10-K 1 v363155_10k.htm FORM 10-K
U. S. SECURITIES AND EXCHANGE COMMISSION
Washington, DC   20549
 
FORM 10-K
(Mark One)
 
x
ANNUAL REPORT PURSUANT TO SECTION 13 0R 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 for the fiscal year ended September 30, 2013.
 
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 for the transition period from ______________ to ______________
 
Commission file number: 000-27503
 
DYNASIL CORPORATION OF AMERICA
(Exact name of registrant as specified in its charter)
 
Delaware
 
22-1734088
(State or other jurisdiction of
 
(I.R.S. Employer
incorporation or organization)
 
Identification No.)
 
 
 
44 Hunt Street, Watertown, MA
 
02472
(Address of principal executive offices)
  
(Zip Code)
 
Registrant’s telephone number, including area code: (617) 668-6855
 
Securities registered pursuant to Section 12(b) of the Act:  
 
Title of each class
 
Name of each exchange on which registered
 
 
 
Common Stock, $0.0005 par value
 
The NASDAQ Stock Market LLC
(NASDAQ Capital Market)
 
Securities registered pursuant to Section 12(g) of the Act:  none
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes ¨   No x
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes ¨   No x
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x     No ¨
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for shorter period that the registrant was required to submit and post such files.) Yes x   No ¨
  
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K x
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.
Large accelerated filer ¨
Accelerated filer ¨
Non-accelerated filer ¨
Smaller reporting company x
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act.)   
Yes ¨ Nox
 
As of March 31, 2013, the aggregate market value of the voting stock held by non-affiliates of the Registrant was approximately $5,857,930.
 
As of December 13, 2013 there were 15,414,242 shares of common stock, par value $.0005 per share, outstanding.
 
 
 
DOCUMENTS INCORPORATED BY REFERENCE
 
Portions of the proxy statement for the Annual Meeting of Stockholders scheduled to be held on February 13, 2014 are incorporated by reference into Part III of this report. 

PART I
 
This annual report on Form 10-K contains or incorporates by reference not only historical information, but also forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, and are subject to the safe harbor created by those sections. We refer you to the information under the heading “Forward-Looking Statements."
 
As used in this annual report on Form 10-K, references to "Dynasil," the "Company," "we," "our" or "us," unless the context otherwise requires, refer to Dynasil Corporation of America and our subsidiaries.
 
All trademarks or trade names referred to in this report are the property of their respective owners.
 
ITEM 1.  BUSINESS
 
General
 
Dynasil Corporation of America was founded as a New Jersey corporation in 1960 and incorporated in the state of Delaware through a migratory merger in March 2008. Our corporate headquarters are located at 44 Hunt Street, Watertown, MA 02472, and our corporate website is www.dynasil.com. You can access, free of charge, our filings with the Securities and Exchange Commission, including our Annual Report on Form 10-K, our quarterly reports on Form 10-Q, current reports on Form 8-K and any other amendments to those reports, through a link at our website, or at the Commission’s website at www.sec.gov.
 
The Company is divided into four reporting segments based on our main operating activities.  Below is a summary of these segments:
 
 
·
Contract Research: The Contract Research segment consists of the Radiation Monitoring Devices, Inc. (“RMD”) business unit, which is among the largest small business participants in U.S. government-funded research. 
 
 
 
 
·
Optics: The Optics segment encompasses four business units – Dynasil Fused Silica, Optometrics,  Hilger Crystals, and Evaporated Metal Films (“EMF”) – that manufacture commercial products, including optical crystals for sensing in the security and medical imaging markets, as well as optical components, optical coatings and optical materials for scientific instrumentation and other applications.
 
 
 
 
·
Instruments: The Instruments segment consists of Dynasil Products (formerly known as RMD Instruments), which manufactures precision instrumentation for medical and commercial applications. Subsequent to our fiscal yearend, we completed the sale of the Lead Paint business in our Instruments segment as discussed in Note 18 in the Notes to the Consolidated Financial Statements.
 
 
2

 
 
·
Biomedical: The Biomedical segment consists of a single business unit, Dynasil Biomedical Corporation (“Dynasil Biomedical”), a medical technology incubator, developing disruptive technologies for a wide spectrum of applications, including hematology, hypothermic core cooling and tissue sealants.  On or about October 1, 2013, Dynasil Biomedical formed Xcede Technologies, Inc. (“Xcede”), a joint venture with Mayo Clinic to spin out and separately fund the development of the tissue sealant technology.  See Note 18 to the Consolidated Financial Statements included in this Report.
 
For information about our segments and geographical information about our operating revenues and assets, see Note 17 to the Consolidated Financial Statements included in this Report. 
 
Our business strategy is based on continued development and expansion of our funded research portfolio, investment in the commercialization of the technologies originating from our Contract Research segment, organic growth of existing Optics segment products, and acquisitions that align with our core competencies.  On December 31, 2012, we announced that we were in default of certain covenants of both our senior and our subordinated bank loans.  As a result of and in response to those defaults, our short term strategy also includes identification of product lines or business units which could be sold in order to repay debt and deleverage our balance sheet.  We expect to continue our efforts to deleverage our balance sheet at least until such time as we are no longer in default of our bank covenants. 
 
Historical Growth by Acquisition
 
Through a series of acquisitions beginning in March 2005, Dynasil has evolved from a single product line optics company to one focused on commercializing its own products, patenting its own innovations and advancing its own technologies. Our revenue has increased from $2 million in FY 2004 to nearly $43 million in FY 2013.
 
The acquisitions we completed during this period included:
 
 
·
Optometrics: In March 2005, we acquired Optometrics LLC (“Optometrics”), a worldwide supplier of optical components and instruments, including diffraction gratings, interference filters, laser optics, monochromators and specialized optical systems.
 
 
 
 
·
Evaporated Metal Films: In October 2006, we acquired Evaporated Metal Films Corporation (“EMF”), an optical thin-film coatings company with a broad range of application markets, including solar energy, display systems, dental photography, optical instruments, satellite communications and lighting.
 
 
 
 
·
RMD: In July 2008, we acquired Radiation Monitoring Devices, Inc. (“RMD”), a contract research company, and RMD Instruments, LLC (“Dynasil Products”), a precision instruments company that manufactures and sells instruments in the medical imaging and industrial markets, including hand-held analyzers for lead paint and medical probes for cancer surgery.
 
 
 
 
·
Hilger Crystals: In July 2010, we acquired Hilger Crystals, Ltd., (“Hilger”) a manufacturer of synthetic crystals applicable to a wide range of industrial, medical, and homeland security applications with a long history of supplying high-quality synthetic crystals for infrared spectroscopy, X-ray and gamma ray detection.
 
 
 
 
·
Biomedical technologies: In April 2011, we acquired the rights to six biomedical technologies from Dr. Daniel Ericson, a former hematologist at the Mayo Clinic, which jointly owns rights to certain of the technologies acquired. We have formed a joint venture to pursue the tissue sealant technology and are seeking opportunities to license, sell or develop several of the development-stage technologies for various therapeutic applications.
 
Contract Research – the Science Behind our Technology
 
Our Contract Research segment’s business unit, RMD, is among the largest small business participants in U.S. government-funded research, performing research and development activities for government agencies including Department of Energy, Department of Defense, Department of Homeland Security, Domestic Nuclear Detection Office, National Institutes of Health and NASA.
 
 
3

 
RMD develops advanced technology in materials, sensors and prototype instruments that detect, use or measure radiation, light, magnetism or sound for use in security, medical and industrial applications. RMD has technology practices in material science, radiation detection, digital imaging technology, magnetic imaging, laser optics and photonics.  As of September 30, 2013, our Contract Research segment had a total of 102 employees, including 37 Ph.D. level scientists.  RMD serves as an incubator to expand our patent portfolio enabling the opportunity to advance our technology from development to commercialization using government-funded research.  As of September 30, 2013, RMD had a portfolio of 48 issued U.S. patents and 42 pending patent applications, compared with 43 issued patents and 55 pending patent applications at the same point in 2012.
 
For more than 25 years, RMD has successfully conducted government research under the auspices of the Small Business Innovation Research (“SBIR”) program.  In recent years, RMD has augmented its SBIR research with larger, competitively bid government research and development contracts. To grow our research portfolio within the federal government, we are broadening our relationships within key federal funding agencies and the U.S. military.  RMD also provides research for non-governmental entities in areas where it has the appropriate expertise. Such research is currently not a significant portion of RMD’s revenues.  Our research initiatives are aligned with our focus on the homeland security, medical and industrial markets.  As of September 30, 2013, RMD had a contract backlog of approximately $40 million, of which approximately 48% is SBIR contracts.
 
RMD competes for contract research work against a variety of small and large entities, including universities that submit research proposals based on specific government solicitations. We generate revenues under various types of contracts, which include cost reimbursement, Time & Materials (T&M), Fixed Price-Level of Effort and Firm Fixed Price (FFP) contracts. We believe that RMD’s reputation for conducting state-of-the art research and development, as well as the quality of its proposals, are significant competitive advantages.  In addition, RMD maintains strong working relationships with universities, government agencies, national laboratories, research hospitals and corporations.  However, some of our competitors may have greater financial, technical and human resources than we have and may be better able to operate large, well-funded research and development programs.
 
We believe that research projects provide an important source for new commercial products in areas such as medical imaging, industrial sensors, critical care and point of care diagnostics and homeland security. For example, our lead paint analyzer and a medical probe for cancer surgery products emanated from the RMD portfolio. Our government-funded research work also has spawned programs such as our dual-mode radiation detection technology.
 
Commercialization Engines
 
We specialize in the production of optical materials, components and coatings for various applications in the medical, industrial, and homeland security/defense sectors.
 
Our Instruments segment manufactures precision instruments such as handheld lead paint analyzers (LPA-1™) and medical probes that help surgeons detect cancer tracers, thereby enabling more effective surgical procedures (the Navigator GPS™ gamma counter and the wireless Navigator 2.0™ gamma counter).  Subsequent to yearend, we sold the lead paint business (see Note 18 to the Consolidated Financial Statements included in this Report).
 
Our Optics segment supplies synthetic crystals, optical materials, components, and coatings that are used for baggage scanners, medical imaging systems, optical instruments, lasers, analytical instruments, semiconductor/electronic devices, automotive components, spacecraft/aircraft components and  advertising displays. These products are offered through four business units (Dynasil Fused Silica, Optometrics, Hilger Crystal, and EMF).
 
Our Biomedical segment is focused on developing disruptive technologies for a wide spectrum of applications, including hematology, hypothermic core cooling and tissue sealants. All of these technologies are in early-stages and may require significant investment to support further development, regulatory approval and commercialization. While Dynasil currently believes that these technologies represent exciting opportunities, there can be no assurances that any of these technologies will be successfully commercialized.  On or about October 1, 2013, Dynasil Biomedical formed Xcede, a joint venture with Mayo Clinic, to spin out and separately fund the development of the tissue sealant technology (see Note 18 to the Consolidated Financial Statements included in this Report).
 
 
4

   
We compete for business with fabricators of industrial optical materials, other optical components manufacturers, other optical crystal manufacturers and other optical coaters as well as other analytical instruments manufacturers and synthetic crystal manufacturers.  We believe our proprietary processes, reputation, specialty product offering, products in development and the price at which we offer our products enable us to successfully compete in these markets.  However, many of our competitors have greater financial, sales and marketing resources than we do, which may enable them to develop and market products that would compete against those developed by us.
 
Our products are distributed through a direct sales and marketing staff of 14 people and through other channels, including manufacturer’s representatives and distributors in various foreign countries for international sales and U.S. manufacturer’s representatives for certain product lines. Marketing efforts include direct customer contact through sales visits, advertising in trade publications and attendance at trade shows.
 
Strategy to Commercialize our Advanced Technologies
 
Our business strategy focuses on combining our expertise in funded research, product development and technology innovation to commercialize detection and analysis equipment for the homeland security, industrial and medical markets. We are executing on this strategy by:
 
 
·
developing and expanding our research portfolio;
 
·
commercializing the technologies coming from our Contract Research segment;
 
·
growing organically through investment in existing businesses; and
 
·
identifying and investing in those technologies with the greatest revenue and growth potential in the market.
 
For example, our dual mode nuclear detector technology was developed by RMD under a program for the Department of Homeland Security for use in locating nuclear bombs or nuclear materials at our nation’s ports and borders. This technology is of critical importance to our national security, as well as other radiation detection applications, such as nuclear power plant safety. Our dual mode detectors are being commercialized as a part of our Optics segment and began generating revenue in 2012. 
 
Our dual mode detector technology is designed to be a single detector that replaces two detector subsystems – the gamma radiation detector and also the helium-3 detectors for neutrons.  Increasing our value proposition is the fact that the stockpile of the chemical element helium-3, a byproduct of nuclear weapons production, is in critically short supply.  The stockpile of helium-3 has been drawn down during the past 10 years, as the federal government has increased its use in neutron detectors to help prevent nuclear and radiological material from being smuggled into the U.S.
 
In order to accelerate the pace of this technology to market, and to establish manufacturing capacity, in July 2010 we acquired Hilger Crystals, a leading manufacturer of scintillation crystals based in Margate, Kent, U.K.
 
Intellectual Property (IP)
 
From October 2012 through September 2013, we have been granted five new U.S. patents and have filed 14 new patent applications.  Our current portfolio, company-wide, is 48 issued and 53 pending applications, most of which are issued to RMD.  We believe that intellectual property represents an important strategic advantage for us. Our Patent Committee is strengthening the identification of intellectual property within the Company through a broad-based vetting process to ensure that we develop IP that maximizes the market value of our research.  This allows us to protect selected technologies that we believe have commercial potential – either through product offerings or licensing agreements.
 
 
5

 
Customers
 
We have more than 1,034 customers, with approximately 51.8% of our business concentrated in our top 10 customers. Our five largest customers are agencies and agents of the Federal government and accounted for approximately 13.0%, 9.2%, 7.2%, 7.0% and 4.5%, respectively, of our revenues during fiscal year 2013. The loss of any of these top five customers would likely have a material adverse effect on our business, financial condition and results of operations. Generally, our customers provide purchase orders for a specific part and quantity or they provide a contract for research projects. Product orders are normally filled over a period ranging from one to six weeks. We also have blanket orders that call for monthly deliveries of predetermined amounts. Contract research projects generally run for a one to two year period.
 
Employees
 
As of September 30, 2013, we had a total of 233 employees, of which 222 are full-time. Of the total, 51 of our employees are engaged in administration, 14 are engaged in sales, 100 are engaged in research and/or engineering and 68 are engaged in manufacturing. The Company has a total of 40 Ph.D. level employees. Our operations are non-union except for a two-person union in one location.
 
Suppliers
 
Our largest supplier for materials and components is Corning Incorporated, which is a primary supplier of the fused silica material that is fabricated and sold by our New Jersey facility.  We believe that we have excellent relationships with our suppliers.  If any of our suppliers should become unavailable to us for any reason, we believe that there are a number of potential replacements, although we might incur some delay in identifying such replacements. 
 
Research and Development
 
Our RMD business unit primarily provides research and development (“R&D”) activities under government funded research contracts.  The RMD business unit recognized revenues of $21.9 million for fiscal year 2013 and $25.3 million for fiscal year 2012.  The direct costs associated with these revenues were $12.1 million and $15.4 million in 2013 and 2012, respectively.  Substantially all the Contract Research segment’s cost of revenue relates to research contracts performed by RMD which are in turn billed to the contracting party. 
 
R&D for our other businesses, which totaled $2.3 million and $2.8 million in 2013 and 2012, respectively, primarily involves new product development, changes to our manufacturing processes and the introduction of improved methods and equipment.
 
Government Regulation
 
The businesses that we operate are subject to various federal and states regulations. 
 
Our Contract Research segment is subject to the rules and regulations applicable to government contracting, including: the Federal Acquisition Regulation (FAR) and supplements, which regulate the formation, administration and performance of U.S. Government contracts; the Truth in Negotiations Act, which requires certification and disclosure of cost and pricing data in connection with certain contract negotiations; the Procurement Integrity Act, which regulates access to competitor bids and proposal information and government source selection information, and our ability to provide compensation to certain former government officials; the Civil False Claims Act, which provides for substantial civil penalties for violations, including for submission of a false or fraudulent claim to the U.S. Government for payment or approval; and the U.S. Government Cost Accounting Standards, which impose accounting requirements that govern our right to reimbursement under certain cost-based U.S. Government contracts.
 
Our handheld lead paint analyzers product business which was sold in November 2013 is subject to certain testing protocols and certifications and accreditation under rules and regulations promulgated by U.S. Department of Housing and Urban Development (“HUD”), the U.S. Environmental Protection Agency (“EPA”), and state and local Lead Renovation Repair Painting Rules (RRP rules).
 
Our Navigator GPS™ and Navigator 2.0™ gamma counter business is subject to the regulations of the Federal Drug Administration (“FDA”) relating to medical devices.  The products being developed by our Biomedical segment are also subject to FDA regulations and approval. 
 
 
6

 
Our use of radioactive materials in certain of our products (our gamma counters, our dual-mode detector and lead paint analyzers) subject us to laws regulating hazardous wastes under United States federal, and Massachusetts, California, Washington and Wisconsin state, environmental and atomic energy regulatory laws and similar laws in each jurisdiction in which our research and manufacturing facilities are located.  Environmental compliance costs, which totaled $84,788 for fiscal year 2013, have not historically had a material effect on our operational results. 
 
With respect to our intellectual property rights, we rely, and are subject to, the laws in the U.S. and abroad governing intellectual property protection.
 
Item 1a.  Risk Factors
 
In your evaluation of our company and our businesses, you should carefully consider the risks and uncertainties described below, together with the information included elsewhere in this Annual Report on Form 10-K and the other documents we file with the SEC.  The following factors describe the risks and uncertainties that we consider significant to the operation of our business, but should not be considered a complete listing of all potential risks and uncertainties that could adversely affect our operating results, financial position or liquidity.  Additionally, our business is subject to the same general risks and uncertainties that affect many other companies, such as the overall U.S. and global economic conditions, international conflicts, geopolitical events, changes in laws or accounting rules, fluctuations in interest and exchange rates or other disruptions of expected economic and business conditions.
 
Risks Related To Our Business
 
We are not in compliance with our financial covenants under our loan agreements with our lenders.  Our lenders may exercise one or more of their available remedies, including the right to require the immediate repayment of all outstanding indebtedness. 
 
Our outstanding indebtedness is as follows:
 
 
 
September 30, 2013
 
September 30, 2012
 
Santander Bank, N.A.
 
$
6,819,000
 
$
8,984,000
 
Massachusetts Capital Resource Co.
 
 
3,000,000
 
 
3,000,000
 
Total Debt
 
$
9,819,000
 
$
11,984,000
 
 
As of September 30, 2013 and September 30, 2012, we were in default of certain covenants under our loan agreement with Santander Bank, N.A. (“Santander”) and our note agreement with Massachusetts Capital Resource Company (“MCRC”), which is subordinated to the Santander Bank loan.  This indebtedness is secured by substantially all of our assets and is guaranteed by our subsidiaries. Our debt agreements include financial covenants which require us to maintain compliance with certain financial ratios during the term of the agreements.  Failure to comply with the financial covenants is an event of default under the debt agreements.  In an event of default, each of the lenders has the right to accelerate repayment of all outstanding indebtedness, impose a higher default interest rate and (in the case of Santander Bank) take any and all action, at its sole option, to collect monies owed to it, including to enforce and foreclose on its security interest on all of our assets.  While we continue to be current with all principal and interest payments with Santander, we have not paid approximately $0.3 million in interest owed to MCRC.  Additionally, as of both September 30, 2012 and 2013 and as of the date hereof, we were in violation of certain financial covenants contained in each of the loan agreements that require us to maintain certain ratios of earnings before interest, taxes, depreciation and amortization to fixed charges and to total/senior debt. 
 
As of the date hereof, neither of our lenders has accelerated our payment obligations.  Subsequent to September 30, 2013, in addition to our regular monthly interest and principal payments, we repaid an additional $1.25 million to Santander from cash received in connection with the sale of our lead paint analyzer business.  We are continuing to evaluate potential alternatives that would resolve our current default status including additional sales transactions, negotiation of a forbearance agreement or a new borrowing arrangement with another lender.  However, we cannot provide any assurance that the alternatives will be successful or that our obligations under our debt agreements will not be accelerated in the future or that our lenders will not exercise other remedies for default.
 
 
7

 
If our lenders were to accelerate our debt payments, our assets may not be sufficient to fully repay the debt and we may not be able to obtain capital from other sources at favorable terms or at all.  If additional funding is required, this funding may not be available on favorable terms, if at all, or without potentially very substantial dilution to our stockholders.  If we do not raise the necessary funds, we may need to curtail or cease our operations, sell certain assets and/or file for bankruptcy, which would have a material adverse effect on our financial condition and results of operations. 
 
The audit report contained in our Annual Report on Form 10-K for the year ended September 30, 2013 contains an explanatory paragraph to the effect that there is doubt about our ability to continue as a going concern.
 
As described in more detail above, we are in default with our financial covenants under our loan agreements as of September 30, 2013.  Accordingly, our lenders have the ability to require immediate payment of all indebtedness under our loan agreements.  While the lenders have not exercised this right, their ability to require immediate payment has caused all of our outstanding indebtedness to be accelerated to current on our consolidated financial statements.  As a result, our independent registered public accounting firm has expressed substantial doubt that we can fund our ongoing operations during the next twelve months.  This “going concern” statement may discourage some third parties from contracting with us and some investors from purchasing our stock or providing alternative capital financing, which could adversely affect our business, financial condition, results of operations and prospects.
 
Our loan agreements impose restrictions on our ability to take certain corporate actions and raise additional capital.
 
Our loan agreements contain numerous customary restrictions that limit our ability to undertake certain activities without the express prior written approval of our lenders. These include, but are not limited to, restricting our ability to:
 
-
incur additional indebtedness;
 
-
pay or declare dividends;
 
-
enter into a business substantially different from existing operations;
 
-
issue or authorize any additional or new equity that will result in a change of control; and
 
-
take any corporate action outside the ordinary course of the business, including without limitation, the sale of assets or other strategic divestitures, without the prior written approval of our lender.
These restrictions could significantly hamper our ability to raise additional capital. Our ability to receive the necessary approvals is largely dependent upon our relationship with our lenders and our financial performance, and no assurances can be given that we will be able to obtain the necessary approvals in the future. Our inability to raise additional capital could lead to working capital deficits that could have a material adverse effect on our operations in future periods.
 
We may not be able to generate sufficient positive cash flow in the future to fund our operations.
 
In addition to our bank financing, we are dependent upon cash flow from our businesses to fund our operations. It is our expectation that we can continue to improve our cash flows; however, there can be no assurance that we will be able to continue to do so.  If we are unable to fund our operations from future cash flows together with our available bank financing, we will need to seek additional debt and/or equity financing, which may not be available on attractive terms, if at all, in which case there could be a material adverse effect on our results of operations and financial condition.
 
Our Xcede joint venture requires further funding to support the development of its technology.
 
On or about October 1, 2013, Dynasil Biomedical formed Xcede, a joint venture with Mayo Clinic, to spin out and separately fund the development of the tissue sealant technology.  Xcede has initiated financing efforts and has received funding from internal sources and outside investors.   We expect Xcede will continue to require periodic outside investor funding in order to pursue clinical trials and further development of its tissue sealant technology.  However, there can be no assurance that Xcede will be able to obtain future financing as needed or on terms which are attractive, in which case it might be required to close its operations and liquidate its assets in which case our investment would likely not be recovered. 
 
 
8

 
The Company relies on its Contract Research segment for approximately half of its revenues. A decline in or temporary suspension of U.S. Government spending, changes in federal budgetary priorities, the timing of contract awards or a restructuring of the SBIR/STTR programs may adversely affect our future revenues and limit our growth prospects.
 
Our Contract Research business unit, RMD, is among the largest small business participants in U.S. government-funded research, performing research and development activities for government agencies including Department of Energy, Department of Defense, Department of Homeland Security, Domestic Nuclear Detection Office, National Institutes of Health, and NASA.  Historically RMD has conducted its government research contracts through the SBIR (Small Business Innovation Research Program) and the STTR (Small Business Technology Transfer Program).  Though RMD has augmented its SBIR contracts with larger competitively bid government contracts in recent years, a reduction in or elimination of the SBIR or the STTR programs could result in our inability to win contracts, as we may not have the resources to compete effectively against much larger, better-funded companies.  Further, a significant decline in overall U.S. Government spending, including in the areas of national security, intelligence and homeland security, a significant shift in its spending priorities, the substantial reduction or elimination of particular defense-related programs or significant delays in contract or task order awards for large programs could adversely affect our future revenues and limit our growth prospects.  While the October 2013 government shutdown did not have a significant impact on the Company, a future government shutdown could result in the suspension of work on contracts in progress or in payment delays which would adversely affect our future revenues and cash flow.
 
The Company relies on a small number of key customers for a substantial portion of its revenues.
 
Ten customers accounted for approximately 51.8% of the Company’s revenues in 2013 and the largest four customers, all agencies of the U.S. Government, accounted for 36.5% of revenues. Although we have had business relationships with these customers for many years, there can be no guarantee that we will be able to win contracts with these agencies in the future. Accordingly our performance could be adversely affected by the loss of one or more of these key customers.
 
We may not realize as revenues the full amounts reflected in our backlog, which could adversely affect our expected future revenues and growth prospects.
 
As of September 30, 2013, our total backlog for Contract Research was approximately $40 million. Backlog consists of existing contracts, approved by agencies in favor of RMD. Note that some contracts are multi-year contracts and are subject to annual funding renewals. Due to the U.S. Government’s ability to not exercise contract options or to terminate, modify or curtail our programs or contracts and the rights of our non-government customers to cancel contracts and purchase orders in certain circumstances, we may realize less than expected or in some cases never realize revenues from some of the contracts that are included in our backlog. Our backlog contains management’s estimate of amounts expected to be realized on contract work that may never be realized as revenues.  If we fail to realize as revenues amounts included in our backlog, our expected future revenues, growth prospects and profitability could be adversely affected.
 
The U.S. Government may terminate, cancel, modify or curtail our contracts at any time prior to their completion and, if we do not replace them, we may be unable to achieve or sustain revenue growth and may suffer a decline in revenues.
 
Many of the U.S. Government programs in which we participate as a contractor or subcontractor may extend for several years and include one or more base years and one or more option years. These programs are normally funded on an annual basis. Under our contracts, the U.S. Government generally has the right not to exercise options to extend or expand our contracts and may otherwise terminate, cancel, modify or curtail our contracts at its convenience. Any decisions by the U.S. Government not to exercise contract options or to terminate, cancel, modify or curtail our major programs or contracts would adversely affect our revenues, revenue growth and profitability.
 
If a government customer terminates a contract for default, we may be exposed to liability, including for excess costs incurred by the customer in procuring undelivered services and products from another source. Depending on the nature and value of the contract, a performance issue or termination for default could cause our actual results to differ from those anticipated and could harm our reputation.
 
 
9

 
Our earnings and profitability may be adversely affected by our failure to accurately estimate and manage costs, time and resources.
 
We generate revenues under various types of contracts, which include cost reimbursement, Time & Materials (T&M), Fixed Price-Level of Effort and Firm Fixed Price contracts (FFP). Our earnings and profitability may vary materially depending on changes in the proportionate amount of revenues derived from each type of contract, the nature of services or products provided, as well as the achievement of performance objectives and the stage of performance at which the right to receive fees, particularly under incentive and award fee contracts, is finally determined. Cost reimbursement and T&M contracts generally have lower profitability than FFP contracts. Our operating results in any period may also be affected, positively or negatively, by variable purchasing patterns by our customers of our more profitable proprietary products. Our failure to accurately estimate costs or the resources and technology needed to perform our contracts or to effectively manage and control our costs during the performance of our work could result, and in some instances has resulted, in reduced profits or in losses. More generally, any increased or unexpected costs or unanticipated delays in connection with the performance of our contracts, including costs and delays caused by contractual disputes or other factors outside of our control, such as performance failures of our subcontractors, natural disasters or other force majeure events, could make our contracts less profitable than expected or unprofitable.
 
Our long-term success will depend upon our ability to successfully develop and commercialize new products and enhance our existing products, which is highly uncertain and subjects us to costly regulatory compliance requirements and delays.
 
One of our business strategies is based on successful commercialization of the technology primarily developed in our RMD business.  We are devoting significant resources to our continuing research and development programs which are designed to develop new products and to enhance and improve our existing products. The successful development of our products and product enhancements is subject to numerous risks, both known and unknown, including:
 
-
unanticipated delays in development or the approval or clearance process by the applicable regulatory authorities;
 
-
access to capital;
 
-
budget overruns;
 
-
other difficulties that could result in the abandonment or substantial change in the design, development and commercialization of new products.
 
The medical devices developed in our Instruments segment are subject to regulation by numerous government agencies, including the U.S. FDA and comparable agencies outside the U.S. To varying degrees, each of these agencies requires us to comply with laws and regulations governing the development, testing, manufacturing, labeling, marketing, and distribution of our medical devices. We cannot guarantee that we will be able to obtain marketing clearance for our new products or enhancements or modifications to existing products. If such approval is obtained, it may:
 
-
take a significant amount of time,
 
-
require the expenditure of substantial resources,
 
-
involve stringent clinical and pre-clinical testing, as well as increased post-market surveillance,
 
-
involve modifications, repairs, or replacements of our products, and
 
-
result in limitations on the proposed uses of our products.
 
Given the uncertainties inherent with product development, introduction, and enhancement our efforts may not be completed on a timely basis or within budget, if at all. Our failure to develop new products and product enhancements on a timely basis or within budget, if at all, could harm our business and prospects.
 
 
10

 
Goodwill and other intangible assets represent approximately 36% of our total assets and any impairment of these assets could negatively impact our results of operations.
 
Non-amortizing intangible assets, including goodwill, are tested for impairment annually or whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Examples of events or changes in circumstances indicating that the carrying value of such intangible assets may not be recoverable could include a significant adverse change in legal factors or in the business climate, an adverse action or assessment by a regulator, unanticipated competition, loss of key personnel, or a more-likely-than-not expectation that a reporting unit or a significant portion of a reporting unit will be sold or otherwise disposed of. In the quarter ended March 31, 2013, the Company recorded an impairment of goodwill and intangible assets totaling approximately $6.8 million associated with its Instruments segment, which experienced delays with regulatory approvals (FDA and HUD) associated with product refreshes.  Any future impairment of goodwill or other intangible assets would have a negative impact on our profitability and financial results.
 
Our failure to establish a strong intellectual property position and enforce our intellectual property rights against others would enable competitors to develop similar or alternative technologies.
 
Our success depends in part on our ability to obtain and maintain intellectual property protection for our technologies. Our policy is to protect our intellectual property by, among other methods, filing U.S. patent applications related to our proprietary technology, inventions and improvements that are important to the development of our business. The U.S. Congress recently passed the Leahy-Smith America Invents Act, or the America Invents Act, which was signed into law in September 2011. The America Invents Act reforms United States patent law in part by changing the standard for patent approval from a “first to invent” standard to a “first to file” standard and developing a post-grant review system. This new legislation changes United States patent law in a way that may weaken our ability to obtain or maintain patent protection for future inventions in the United States.
 
Our patent portfolio relating to our proprietary technology is comprised of issued patents and pending patent applications which, in either case, we own directly or for which we are the exclusive or semi-exclusive licensee. Some of these patents and patent applications are foreign counterparts of U.S. patents or patent applications. We may not be able to maintain and enforce existing patents or obtain further patents for our products, processes and technologies. Even if we are able to maintain our existing patents or obtain further patents, these patents may not provide us with substantial protection or be commercially beneficial. The issuance of a patent is not conclusive as to its validity or enforceability, nor does it provide the patent holder with freedom to operate unimpeded by the patent rights of others. Patent law relating to the scope of claims in the technology fields in which we operate is still evolving and the extent of future protection is highly uncertain, so there can be no assurance that the patent rights that we have or may obtain will be valuable. Others have filed patent applications that are similar in scope to ours, and in the future are likely to file patent applications that are similar or identical in scope to ours or those of our licensors. We cannot predict whether any of our competitors’ pending patent applications will result in the issuance of valid patents. Moreover, we cannot assure investors that any such patent applications will not have priority or dominate over our patents or patent applications. The invalidation of key patents owned by or licensed to us or non-approval of pending patent applications could increase competition, and materially adversely affect our business, financial condition and results of operations. Furthermore, there can be no assurance that others will not independently develop similar or alternative technologies, duplicate any of our technologies, or, if patents are issued to us, design around the patented technologies developed by us.
 
Dynasil Biomedical is a pre-clinical stage business with no approved products, which makes it difficult to assess this business’s future viability.
 
Dynasil Biomedical is a preclinical-stage biomedical business with a limited operating history. On or about, October 1, 2013, Dynasil Biomedical formed Xcede, a joint venture with Mayo Clinic, to spin out and separately fund the development of the tissue sealant technology. We have not yet demonstrated an ability to successfully overcome many of the risks and uncertainties frequently encountered by companies in new and rapidly evolving fields, particularly in the biomedical area. For example, to execute our business plan, we will need to successfully:
 
-
execute product candidate development activities;
 
-
oversee the product development and fundraising activities of its joint venture, Xcede;
 
-
develop and maintain any new strategic relationships we elect to enter into;
 
-
manage our spending as costs and expenses increase due to preclinical development, clinical trials, regulatory approvals and commercialization.
 
-
obtain required regulatory approvals for the development and commercialization of our product candidates;
 
 
11

 
 
-
maintain, leverage and expand our intellectual property portfolio;
 
-
build and maintain robust sales, distribution and marketing capabilities, either on our own or in collaboration with strategic partners;
 
-
gain market acceptance for our products;
 
If we are unsuccessful in accomplishing these objectives, we may not be able to develop product candidates, raise capital, expand our business or continue our operations.
 
We compete in the optics industry and may be unable to compete effectively.
 
Our Optics companies’ business is highly competitive and we compete with larger companies that have greater name recognition, financial resources and larger technical staffs, such as Newport Corporation and JDSU. We also compete with smaller, more specialized companies that are able to concentrate their resources on particular areas.  The markets in which we operate are characterized by rapidly changing technology and the needs of our customers change and evolve regularly.  Accordingly, our success depends on our ability to develop services and products that address these changing needs and to provide people and technology needed to deliver these services and products. To remain competitive, we must consistently provide superior service, technology and performance on a cost-effective basis to our customers. Our competitors may be able to provide our customers with different or greater capabilities or technologies or better contract terms than we can provide, including technical qualifications, past contract experience, geographic presence, price and the availability of qualified professional personnel. In addition, our competitors may consolidate or establish teaming or other relationships among themselves or with third parties to increase their ability to address customers’ needs. Accordingly, we anticipate that larger or new competitors or alliances among competitors may emerge which may adversely affect our ability to compete.
 
Our failure to compete effectively in this market could have a material adverse effect on our results or operation and financial condition.
 
Our Contract Research business faces aggressive competition that can impact our ability to obtain contracts and therefore affect our future revenues and growth prospects.
 
RMD’s competitors include other small high technology companies performing SBIR R&D, large firms such as Raytheon which performs related R&D, and to some extent, universities and national laboratories.
 
The markets in which we operate are characterized by rapidly changing technology and the needs of our customers change and evolve regularly. Accordingly, our success depends on our ability to develop services and products that address these changing needs and to provide people and technology needed to deliver these services and products. To remain competitive, we must consistently provide superior service, technology and performance on a cost-effective basis to our customers. Our competitors may be able to provide our customers with different or greater capabilities or technologies or better contract terms than we can provide, including technical qualifications, past contract experience, geographic presence, price and the availability of qualified professional personnel. In addition, our competitors may consolidate or establish teaming or other relationships among themselves or with third parties to increase their ability to address customers’ needs. Accordingly, we anticipate that larger or new competitors or alliances among competitors may emerge which may adversely affect our ability to compete.
 
Our internal controls over financial reporting were not effective as of September 30, 2012 or 2013.
 
  The Sarbanes-Oxley Act requires, among other things, that we maintain effective internal control over financial reporting and disclosure controls and procedures. In particular, we must perform system and process evaluation and testing of our internal control over financial reporting to allow management to report on the effectiveness of our internal control over financial reporting, as required by Section 404(a) of the Sarbanes-Oxley Act.  Our management, including the Chief Executive Officer and the Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures and of our internal control over financial reporting as of September 30, 2012 and concluded that, as of that date, our disclosure controls and procedures were not effective as a result of material weaknesses in our internal control over financial reporting.  While we have undertaken remediation efforts as discussed in Item 9A of this Form 10-K during fiscal year 2013, the Company concluded that adequate improvement has not yet been made to remediate the previously identified material weaknesses and has determined as of September 30, 2013 that, collectively, the control deficiencies that existed in the prior year still rise to the level of a material weakness described in management’s report in Item 9A. Until these issues are corrected and the changes made are operational for a sufficient period of time to demonstrate their effectiveness, our ability to report financial results or other information required to be disclosed on a timely and accurate basis may be adversely affected.  In addition, remedying this matter may require additional management time and resources and cause the Company to incur additional costs.
 
 
12

 
Our ability to use our federal and state tax credits and our state and foreign net operating loss carryforwards (“NOLs”) could be substantially limited or eliminated as we may not generate sufficient future taxable income.
 
As of September 30, 2013, we had approximately $1.5 million in federal and state tax credits and approximately $4.2 million of state NOLs available to offset future taxable income, which expire in varying amounts beginning in 2031, if unused. We had $182,000 of foreign NOLs which can be carried forward indefinitely. We may not generate taxable income in time to use these tax credits or the NOLs prior to their expiration, and the Internal Revenue Service may not agree with the amount or timing of prior losses, thereby limiting the value of our NOLs. Furthermore, our ability to use our NOLs is subject to an annual limitation due to ownership changes that may have occurred or that could occur in the future, as determined by Section 382 of the Internal Revenue Code of 1986, as amended, as well as similar state regulations. Depending on the actual amount of any limitation on our ability to use our tax credits and NOLs, our future taxable income could be subject to federal and/or state income tax, creating federal and/or state income tax liabilities.
 
Our business is subject to reviews, audits and cost adjustments by the U.S. Government, which, if resolved unfavorably to us, could adversely affect our profitability, cash position or growth prospects.
 
U.S. Government agencies, including the DCAA (Defense Contract Audit Agency), DCMA (Defense Contract Management Agency) and others, routinely audit and review a contractor’s performance on government contracts, indirect rates and pricing practices, and compliance with applicable contracting and procurement laws, regulations and standards. They also review the adequacy of the contractor’s compliance with government standards for its accounting and management internal control systems, including: control environment and overall accounting system, estimating system, purchasing system, property system and earned value management system. Both contractors and the U.S. Government agencies conducting these audits and reviews have come under increased scrutiny.
 
A finding of significant control deficiencies in our system audits or other reviews could result in decremented billing rates to our U.S. Government customers until the control deficiencies are corrected and our corrections are accepted by the auditing agency. Government audits and reviews may conclude that our practices are not consistent with applicable laws and regulations and result in adjustments to contract costs and mandatory customer refunds. Such adjustments can be applied retroactively, which could result in significant customer refunds. Our receipt of adverse audit findings or the failure to obtain an “approved” determination of our various accounting and management internal control systems, including our changes to indirect cost and direct labor estimating systems, from the responsible U.S. Government agency could significantly and adversely affect our business, including our ability to bid on new contracts and our competitive position in the bidding process. A determination of non-compliance with applicable contracting and procurement laws, regulations and standards could also result in the U.S. Government imposing penalties and sanctions against us, including withholding of payments, suspension of payments and increased government scrutiny that could delay or adversely affect our ability to invoice and receive timely payment on contracts, perform contracts or compete for contracts with the U.S. Government. We may suffer harm to our reputation if allegations of impropriety are made against us, which would impair our ability to win new contract awards or receive contract renewals.
 
Due to significant delays at the DCAA in auditing small firms performing SBIR research, our indirect cost audits by the DCAA have not been completed for fiscal 2010 and subsequent fiscal years. Although we have recorded contract revenues subsequent to fiscal 2010 based upon our estimate of costs that we believe will be approved upon final audit or review, we do not know the outcome of any ongoing or future audits or reviews and adjustments and, if future adjustments exceed our estimates, our profitability would be adversely affected.
 
 
13

 
Our failure to comply with a variety of complex procurement rules and regulations could result in our being liable for penalties, including termination of our U.S. Government contracts, disqualification from bidding on future U.S. Government contracts and suspension or debarment from U.S. Government contracting.
 
We must comply with laws and regulations relating to the formation, administration and performance of U.S. Government contracts, which affect how we do business with our customers and may impose added costs on our business. Some significant statutes and regulations that affect us include:
 
·
the Federal Acquisition Regulation (FAR) and supplements, which regulate the formation, administration and performance of U.S. Government contracts;
 
·
the Truth in Negotiations Act, which requires certification and disclosure of cost and pricing data in connection with certain contract negotiations;
 
·
the Procurement Integrity Act, which regulates access to competitor bid and proposal information and government source selection information, and our ability to provide compensation to certain former government officials;
 
·
the Civil False Claims Act, which provides for substantial civil penalties for violations, including for submission of a false or fraudulent claim to the U.S. Government for payment or approval; and
 
·
the U.S. Government Cost Accounting Standards, which impose accounting requirements that govern our right to reimbursement under certain cost-based U.S. Government contracts.
 
Our failure to comply with any of these rules or regulations could result in loss of business or penalties that could have a material adverse effect on our financial condition or results of operations.
 
We depend on our teaming arrangements and relationships with other contractors and subcontractors. If we are not able to maintain these relationships, or if these parties fail to satisfy their obligations to us or our customers, our revenues, profitability and growth prospects could be adversely affected.
 
We rely on our teaming relationships with other prime contractors and subcontractors in order to submit bids for large procurements or other opportunities where we believe the combination of services and products provided by us and the other companies will help us to win and perform the contract. Our future revenues and growth prospects could be adversely affected if other contractors eliminate or reduce their contract relationships with us, or if the U.S. Government terminates or reduces these other contractors’ programs, does not award them new contracts or refuses to pay under a contract. Companies that do not have access to U.S. Government contracts may perform services as our subcontractor and that exposure could enhance such companies’ prospect of securing a future position as a prime U.S. Government contractor which could increase competition for future contracts and impair our ability to perform on contracts.
 
We may have disputes with our subcontractors arising from, among other things, the quality and timeliness of work performed by the subcontractor, customer concerns about the subcontractor, our failure to extend existing task orders or issue new task orders under a subcontract, our hiring of a subcontractor’s personnel or the subcontractor’s failure to comply with applicable law. Current uncertain economic conditions (including risks associated with possible future government shutdowns) heighten the risk of financial stress of our subcontractors, which could adversely impact their ability to meet their contractual requirements to us. If any of our subcontractors fail to timely meet their contractual obligations or have regulatory compliance or other problems, our ability to fulfill our obligations as a prime contractor or higher tier subcontractor may be jeopardized. Significant losses could arise in future periods and subcontractor performance deficiencies could result in our termination for default. A termination for default could eliminate a revenue source, expose us to liability and have an adverse effect on our ability to compete for future contracts and task orders, especially if the customer is an agency of the U.S. Government.
 
 
14

 
Our failure to attract, train and retain skilled employees, including our management team, would adversely affect our ability to execute our strategy.
 
Portions of our business involve the development of tailored solutions for our customers, a process that relies heavily upon the expertise and services of our employees. Our continued success depends on our ability to recruit and retain highly trained and skilled engineering, technical and professional personnel. Competition for skilled personnel is intense and competitors aggressively recruit key employees. Particularly in highly specialized areas, it has become more difficult to retain employees and meet all of our needs for employees in a timely manner, which may affect our growth in the current fiscal year and in future years. Although we intend to continue to devote significant resources to recruit, train and retain qualified employees, we may not be able to attract and retain these employees. Any failure to do so could impair our ability to perform our contractual obligations efficiently and timely meet our customers’ needs and win new business, which could adversely affect our future results.
 
In addition to attracting and retaining qualified engineering, technical and professional personnel, we believe that our success will also depend on the continued employment of a highly qualified and experienced senior management team and its ability to retain existing business and generate new business. Our senior management team is important to our business because personal reputations and individual business relationships are a critical element of retaining and obtaining customer contracts in our industry, particularly with agencies performing classified operations. Our inability to hire and retain appropriately qualified and experienced senior executives could cause us to lose customers or new business opportunities.
 
Misconduct of employees, subcontractors, agents and business partners could cause us to lose existing contracts or customers and adversely affect our ability to obtain new contracts and customers and could have a significant adverse impact on our business and reputation.
 
Misconduct, should it occur, could include fraud or other improper activities such as falsifying time or other records and violations of laws, including the Anti-Kickback Act. Other examples could include the failure to comply with our policies and procedures or with federal, state or local government procurement regulations, regulations regarding the use and safeguarding of classified or other protected information, legislation regarding the pricing of labor and other costs in government contracts, laws and regulations relating to environmental, health or safety matters, bribery of foreign government officials, import-export control, lobbying or similar activities, and any other applicable laws or regulations.  Intentional or unintentional violation of the Export Control Act or ITAR could result in sever fines which could adversely affect our profitability.  Any data loss or information security lapses resulting in the compromise of personal information or the improper use or disclosure of sensitive or classified information could result in claims, remediation costs, regulatory sanctions against us, loss of current and future contracts and serious harm to our reputation. Although we have implemented policies, procedures and controls to prevent and detect these activities, these precautions may not prevent all misconduct, and as a result, we could face unknown risks or losses. Our failure to comply with applicable laws or regulations or misconduct by any of our employees, subcontractors, agents or business partners could damage our reputation and subject us to fines and penalties, restitution or other damages, loss of security clearance, loss of current and future customer contracts and suspension or debarment from contracting with federal, state or local government agencies, any of which would adversely affect our business and our future results.
 
Quality problems with our processes, goods, and services could harm our reputation for producing high-quality products and erode our competitive advantage, sales, and market share.
 
Quality is extremely important to us and our customers due to the serious and costly consequences of product failure. Our quality certifications are critical to the marketing success of our goods and services. If we fail to meet these standards, our reputation could be damaged, we could lose customers, and our revenue and results of operations could decline. Aside from specific customer standards, our success depends generally on our ability to manufacture to exact tolerances precision-engineered components, subassemblies, and finished devices from multiple materials. If our components fail to meet these standards or fail to adapt to evolving standards, our reputation as a manufacturer of high-quality components will be harmed, our competitive advantage could be damaged, and we could lose customers and market share.
 
Product liability claims could adversely impact our financial condition and our earnings and impair our reputation.
 
Our business exposes us to potential product liability risks that are inherent in the design, manufacture, and marketing of medical devices and detection instruments. Component failures, manufacturing defects, design flaws, or inadequate disclosure of product-related risks or product-related information with respect to our products could result in an unsafe condition or injury to, or death of, a patient. The occurrence of such a problem could result in product liability claims or a recall of, or safety alert relating to, one or more of our products. We have purchased, product liability insurance policies, but there is no assurance that the insurance coverage would apply to the circumstances in any liability claim.  Nor is there assurance that the policy limits would be sufficient to cover all costs and liabilities. Product liability claims or product recalls in the future, regardless of their ultimate outcome, could have a material adverse effect on our business and reputation and on our ability to attract and retain customers for our products.
 
 
15

 
From time to time we may make acquisitions. The failure to successfully integrate future acquisitions could harm our business, financial condition and operating results.
 
One component of our growth strategy is to selectively pursue strategic acquisitions. These transactions require significant investment of time and resources and may disrupt our business and distract our management from other responsibilities. Even if successful, these transactions could reduce earnings for a number of reasons, including the amortization of intangible assets, impairment charges, acquired operations that are not yet profitable or the payment of additional consideration under earn-out arrangements if an acquisition performs better than expected. Acquisitions, investments and joint ventures pose many other risks that could adversely affect our reputation, operations or financial results, including:
 
-
we may not be able to identify, compete effectively for or complete suitable acquisitions and investments at prices we consider attractive;
 
-
we may not be able to accurately estimate the financial effect of acquisitions and investments on our business and we may not realize anticipated synergies or acquisitions may not result in improved operating performance;
 
-
we may encounter performance problems with acquired technologies, capabilities and products, particularly with respect to those that are still in development when acquired;
 
-
we may have trouble retaining key employees and customers of an acquired business or otherwise integrating such businesses, such as incompatible accounting, information management, or other control systems, which could result in unforeseen difficulties;
 
-
we may assume material liabilities that were not identified as part of our due diligence or for which we are unable to receive a purchase price adjustment or reimbursement through indemnification;
 
-
we may assume legal or regulatory risks, particularly with respect to smaller businesses that have immature business processes and compliance programs;
 
-
acquired entities or joint ventures may not operate profitably, which could adversely affect our operating income or operating margins and we may be unable to recover investments in any such acquisitions;
 
-
acquisitions, investments and joint ventures may require us to spend a significant amount of cash or to issue capital stock, resulting in dilution of ownership; and
 
-
we may not be able to effectively influence the operations of our joint ventures or we may be exposed to certain liabilities if our joint venture partners do not fulfill their obligations.
 
If our acquisitions fail, perform poorly or their value is otherwise impaired for any reason, including contractions in credit markets and global economic conditions, our business and financial results could be adversely affected. In addition, we periodically divest businesses, including businesses that are no longer a part of our ongoing strategic plan. These divestitures similarly require significant investment of time and resources, may disrupt our business, distract management from other responsibilities and may result in losses on disposal or continued financial involvement in the divested business, including through indemnification, guarantee or other financial arrangements, for a period of time following the transaction, which would adversely affect our financial results.
 
Our financial results may vary significantly from period-to-period.
 
Our financial results may fluctuate as a result of a number of factors, many of which are outside of our control. For these reasons, comparing our operating results on a period-to-period basis may not be meaningful, and you should not rely on our past results as an indication of our future performance. Our financial results may be negatively affected by any of the risk factors listed in this “Risk Factors” section and other matters described elsewhere in this Annual Report on Form 10-K and the other documents we file with the SEC.
 
 
16

 
Changes in tax laws or exposure to additional income tax liabilities could have a material impact on our financial condition and results of operations.
 
We are subject to income taxes as well as non-income based taxes, in both the U.S. and U.K. We are subject to tax audits in various jurisdictions. Tax authorities may disagree with certain positions we have taken and assess additional taxes. We regularly assess the likely outcomes of these audits in order to determine the appropriateness of our tax provision. However, there can be no assurance that we will accurately predict the outcomes of these audits, and the actual outcomes of these audits could have a material impact on our consolidated earnings and financial condition. Additionally, changes in tax laws or tax rulings could materially impact our effective tax rate.
 
We face risks associated with our international business.
 
In 2013 and 2012, we generated approximately 18.1% and 17.5% of our sales outside the U.S. Our international business operations may be subject to additional and different risks than our U.S. business. Our ability to achieve and maintain profitable growth in international markets is subject to risks related to the differing legal, political, social and regulatory requirements and economic conditions of many countries. As a result of our expansion outside the U.S., we are subject to certain inherent risks, including political and economic uncertainty, inflation rates, exchange rates, trade protection measures, local labor conditions and laws, restrictions on foreign investments and repatriation of earnings, and weak intellectual property protection.  If we are unable to manage these risks it would have a material adverse effect on our results of operations and financial condition.
 
Increases in prices and declines in the availability of raw materials could negatively impact our financial results.
 
Our financial results are significantly affected by the cost of raw materials and energy. Most of the raw materials and energy used in production are purchased from outside sources, and the Company has made, and plans to continue to make, supply arrangements to meet the planned operating requirements for the future. Supply of critical raw materials and energy is managed by establishing contracts, multiple sources, and identifying alternative materials or technology whenever possible.  An inability to obtain critical raw materials would adversely impact our ability to produce products. Increases in the cost of raw materials and energy may have an adverse effect on our earnings or cash flow in the event we are unable to mitigate these higher costs in a timely manner.
 
Our business and operations expose us to numerous legal and regulatory requirements and any violation of these requirements could harm our business.
 
We are subject to numerous federal, state and foreign legal requirements on matters as diverse as data privacy and protection, employment and labor relations, immigration, taxation, anticorruption, import/export controls, trade restrictions, internal and disclosure control obligations, securities regulation, environmental and anti-competition. We are also focused on expanding our business in certain identified growth areas, such as homeland security and biomedical technologies, which are highly regulated and may expose us to increased compliance risk. Compliance with diverse and changing legal requirements is costly, time-consuming and requires significant resources. Violations of one or more of these requirements in the conduct of our business could result in significant fines and other damages, criminal sanctions against us or our officers, prohibitions on doing business and damage to our reputation. Violations of these regulations or contractual obligations related to regulatory compliance in connection with the performance of customer contracts could also result in liability for significant monetary damages, fines and/or criminal prosecution, unfavorable publicity and other reputational damage, restrictions on our ability to compete for certain work and allegations by our customers that we have not performed our contractual obligations.
 
Moreover, we use controlled hazardous and radioactive materials in our business and generate wastes that are regulated as hazardous wastes under United States federal, and Massachusetts, California, Washington and Wisconsin state, environmental and atomic energy regulatory laws and similar laws in each jurisdiction in which our research and manufacturing facilities are located. Our use of these substances and materials is subject to stringent, and periodically changing, regulation that can impose costly compliance obligations on us and have the potential to adversely affect our manufacturing activities. The risk of accidental contamination or injury from these materials cannot be completely eliminated. If an accident with these substances occurs, we could be held liable for any damages that result, in addition to incurring clean-up costs and liabilities, which can be substantial. Additionally, an accident could damage our research and manufacturing facilities resulting in delays and increased costs.
 
 
17

 
Our insurance may be insufficient to protect us from product and other liability claims or losses.
 
We maintain insurance coverage with third-party insurers as part of our overall risk management strategy and because some of our contracts require us to maintain specific insurance coverage limits. However, not every risk or liability is or can be protected by insurance, and, for those risks we insure, the limits of coverage we purchase or that are reasonably obtainable in the market may not be sufficient to cover all actual losses or liabilities incurred. If any of our third-party insurers fail, cancel our coverage or otherwise are unable to provide us with adequate insurance coverage, then our overall risk exposure and our operational expenses would increase and the management of our business operations would be disrupted. Our insurance may be insufficient to protect us from significant product and other liability claims or losses. Moreover, there is a risk that commercially available liability insurance will not continue to be available to us at a reasonable cost, if at all. If liability claims or losses exceed our current or available insurance coverage, our business and prospects may be harmed. Regardless of the adequacy of our liability insurance coverage, any significant claim may have an adverse effect on our industry and market reputation, leading to a substantial decrease in demand for our products and services and reduced revenues.
 
Our business and financial results could be negatively affected by cyber or other security threats.
 
As a U.S. Government contractor operating in multiple regulated industries and geographies, we handle sensitive information. Therefore, we are continuously exposed to cyber and other security threats, including computer viruses, attacks by hackers or physical break-ins. Any electronic or physical break-in or other security breach or compromise may jeopardize security of information stored or transmitted through our information technology systems and networks. This could lead to disruptions in mission critical systems, unauthorized release of confidential or otherwise protected information and corruption of data. Although we have implemented policies, procedures and controls to protect against, detect and mitigate these threats, attempts by others to gain unauthorized access to our information technology systems are becoming more sophisticated. These attempts include covertly introducing malware to our computers and networks and impersonating authorized users, among others, and may be perpetrated by well-funded organized crime or state sponsored efforts. We seek to detect and investigate all security incidents and to prevent their occurrence or recurrence. We continue to improve our threat protection, detection and mitigation policies, procedures and controls. In addition, we work with other companies in the industry and government participants on increased awareness and enhanced protections against cyber security threats. However, because of the evolving nature of these security threats, there can be no assurance that our policies, procedures and controls have or will detect or prevent any of these threats and we cannot predict the full impact of any such incident. We may experience similar security threats to the information technology systems that we develop, install or maintain under customer contracts. Although we work cooperatively with our customers and other business partners to seek to minimize the impacts of cyber and other security threats, we must rely on the safeguards put in place by those entities. Any remedial costs or other liabilities related to cyber or other security threats may not be fully insured or indemnified by other means. Occurrence of any of these security threats could adversely affect our reputation, ability to work on sensitive U.S. Government contracts, business operations and financial results.
 
Business disruptions caused by natural disasters and other crises could adversely affect our profitability and our overall financial position.
 
We have operations located in regions of the United States and the U.K. that may be exposed to damaging storms and other natural disasters, such as hurricanes, tornadoes, blizzards, flooding or earthquakes. Our business could also be disrupted by pandemics and other national or international crises. Although preventative measures may help mitigate the damage from such occurrences, the damage and disruption to our business resulting from any of these events may be significant. If our insurance and other risk mitigation mechanisms are not sufficient to recover all costs, including loss of revenues from sales to customers, we could experience a material adverse effect on our financial position and results of operations. Performance failures and disruptions by our subcontractors due to these types of events may also adversely affect our ability to perform our obligations on a prime contract, which could reduce our profitability due to damages or other costs that may not be fully recoverable from the subcontractor or the customer and could result in a termination of the prime contract and have an adverse effect on our ability to compete for future contracts.
 
 
18

 
Risks Relating To Dynasil’s Stock 
 
The market price for our common stock is particularly volatile given our status as a relatively unknown company with a small and thinly traded public float and lack of profits, which could lead to wide fluctuations in our share price. You may be unable to sell your common stock at or above your purchase price, which may result in substantial losses to you.
 
The market for our common stock is characterized by significant price volatility when compared to the shares of larger, more established companies that have large public floats, and we expect that our share price will continue to be more volatile than the shares of such larger, more established companies for the indefinite future. The volatility in our share price is attributable to a number of factors. First, as noted above, our common stock is, compared to the shares of such larger, more established companies, sporadically and thinly traded. As a consequence of this limited liquidity, the trading of relatively small quantities of shares by our stockholders may disproportionately influence the price of those shares in either direction. The price for our shares could, for example, decline precipitously in the event that a large number of our common stock is sold on the market without commensurate demand. As a consequence of this enhanced risk, more risk-adverse investors may, under the fear of losing all or most of their investment in the event of negative news or lack of progress, be more inclined to sell their shares on the market more quickly and at greater discounts than would be the case with the stock of a larger, more established company that has a large public float. Many of these factors are beyond our control and may decrease the market price of our common stock, regardless of our operating performance. We cannot make any predictions or projections as to what the prevailing market price for our common stock will be at any time, including as to whether our common stock will sustain its current market price, or as to what effect that the sale of shares or the availability of common stock for sale at any time will have on the prevailing market price.
 
If we do not regain compliance with certain listing requirements by March 24, 2014, we will be delisted from the NASDAQ Capital Market, which could impair the liquidity of our stock and our availability to access the capital markets.
 
The NASDAQ Stock Market requires that companies remain in compliance with the Global Market Continued Listing Requirements for their common stock as set forth in Marketplace Rule 5450(a) and at least one of the Standards in Rule 5450(b). On March 26, 2013, the Company received notice from Nasdaq that, because the closing bid price for the Company’s common stock had fallen below $1.00 per share for 30 consecutive business days, the Company was no longer in compliance with the minimum bid listing requirements for continued listing on the Nasdaq Global Select Market.  The Company was provided an initial 180 period to regain compliance with the minimum bid requirement.  That period ended on September 23, 2013 without the Company achieving compliance. As a result of its continued noncompliance, the Company requested a transfer to the NASDAQ Capital Market (which also has a $1.00 minimum bid requirement) and, in connection therewith received a second 180 day period to regain compliance with the minimum bid requirement.  We can make no assurance that we will be able to regain compliance with the minimum bid requirement by the  March 24, 2014 deadline or continue to comply with any of the other listing requirements and, consequently, whether or not we will be able to remain listed on the NASDAQ Stock Market.  If we are de-listed by Nasdaq the liquidity of our common stock could be impaired and we could have more difficulty raising capital, which could have an adverse effect on our results of operations and financial condition.
 
We do not currently intend to pay dividends on our common stock and, consequently, your ability to achieve a return on your investment will depend on appreciation in the price of our common stock.
 
We have never declared or paid any cash dividends on our common stock and do not currently intend to do so for the foreseeable future. We currently intend to invest our future earnings, if any, to fund our growth. Therefore, you are not likely to receive any dividends on your common stock for the foreseeable future and the success of an investment in shares of our common stock will depend upon any future appreciation in its value. There is no guarantee that shares of our common stock will appreciate in value or even maintain the price at which our stockholders have purchased their shares.
 
 
19

 
ITEM 2.  PROPERTIES
 
We own a manufacturing and office facility consisting of a one-story, masonry and steel building containing approximately 15,760 square feet in West Berlin, New Jersey.  We lease a 10,000 square foot manufacturing and office building in Ayer, MA with a lease that expires in May 2025.  We lease 3,600 square feet of office space in a building in Littleton, MA with a lease that expires in July 2018.  We own a two-story, 44,000 square foot manufacturing and office facility in Ithaca, New York.  We own a two-story, 17,000 square foot manufacturing and office facility in Margate, Kent, in the U.K.  We lease a 40,000 square foot manufacturing, research, and office building in Watertown, MA for our RMD and Dynasil Products business units from a related party with leases that are month-to-month tenancies and continue until terminated by the landlord with not less than three years’ prior written notice or by the Company with not less than six months’ prior written notice.  We also lease 11,600 square feet of office and research space in buildings within close proximity in Watertown, MA with one lease that expires February 2014 and two leases that are month-to-month. The Watertown locations are the primary location for our corporate offices and contract research segment.  We also lease 2,030 square feet of office and research space in Rochester, MN with a lease that expires in October of 2016. We believe that the properties are in satisfactory condition and suitable for our purposes.  The New Jersey, New York, and U.K. properties are collateral against notes payable to banks. 
 
ITEM 3.  LEGAL PROCEEDINGS
 
None.
 
ITEM 4.  MINE SAFETY DISCLOSURES
 
Not applicable.
 
PART II
 
ITEM 5.  MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
 
Market Information
Since September 30, 2013, the Company’s Common Stock has been listed on the NASDAQ Capital Market under the symbol “DYSL”.  From December 17, 2010 until September 30, 2013, the Company’s Common Stock was listed on the NASDAQ Global Market. Prior to December 17, 2010, the Company’s Common Stock was quoted on the NASD-OTC Bulletin Board under the symbol "DYSL.OB".  
 
The following table reflects the range of high and low common stock sales prices for the four quarters of 2013 and 2012 as reported by the NASDAQ Global Market. The “high” and “low” bid information reflect inter-dealer prices without retail mark-up, mark-down, or commissions, and may not necessarily represent actual transactions.
 
 
 
High & Low Sale Prices
 
 
 
Years ended September 30,
 
 
 
2013
 
2012
 
 
 
High
 
Low
 
High
 
Low
 
First quarter
 
$
1.94
 
$
1.04
 
$
2.97
 
$
1.47
 
Second quarter
 
 
1.25
 
 
0.63
 
 
2.42
 
 
1.72
 
Third quarter
 
 
0.86
 
 
0.40
 
 
2.35
 
 
1.05
 
Fourth quarter
 
 
1.00
 
 
0.58
 
 
1.65
 
 
1.03
 
 
As of December 13, 2013 there were 15,414,242 shares of the Company’s common stock outstanding held by approximately 1,260 holders of record.
 
The Company has paid no cash dividends on its common stock since its inception. The Company intends to retain any future earnings for use in its business and does not intend to pay cash dividends on its common stock in the foreseeable future.  The Company is currently in default under the loan documents with Santander Bank, N.A., which means the Company is contractually prohibited under these documents from paying cash dividends to its stockholders.
 
 
20

 
ITEM 6.   SELECTED FINANCIAL DATA
 
Dynasil, a smaller reporting company, is not required to complete this item.
 
ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS   
 
The following management's discussion and analysis should be read in conjunction with our financial statements and the notes thereto appearing elsewhere in this Form 10-K.
 
Overview
 
The Company is divided into four reporting segments based on our main operating activities.  Below is a summary of these segments:
 
 
·
Contract Research: The Contract Research segment consists of the Radiation Monitoring Devices, Inc. (“RMD”) business unit. 
 
 
 
 
·
Optics: The Optics segment encompasses four business units (our original optics business (“Dynasil Fused Silica”), Optometrics, Hilger Crystal, and EMF) that manufacture commercial products, including optical crystals for sensing in the security and medical imaging markets, as well as optical components, optical coatings and optical materials for scientific instrumentation and other applications.
 
 
 
 
·
Instruments: The Instruments segment consists of Dynasil Products (formerly known as RMD Instruments), which manufactures precision instrumentation for medical and commercial applications.
 
 
 
 
·
Biomedical: The Biomedical segment consists of a single business unit, Dynasil Biomedical Corporation (“Dynasil Biomedical”), a medical technology incubator, developing disruptive technologies for a wide spectrum of applications, including hematology, hypothermic core cooling and tissue sealants. 
 
For information about our financial segments and geographical information about our operating revenues and assets, see Note 17 to the Consolidated Financial Statements included in this Report.  A description of our strategy is included in Item 1 of this Form 10-K.
 
Our markets are characterized by rapidly changing technology and the needs of our customers change and evolve regularly. Accordingly, our success depends on our ability to develop services and products that address these changing needs and to provide the people and technology needed to deliver these services and products. To remain competitive, we must consistently provide superior service, technology and performance on a cost-effective basis to our customers. Our business performance also is influenced by a variety of other factors including, but not limited to, economic conditions, U.S. Government spending on research and development programs, the availability of Research & Experimentation tax credits, competition, regulatory requirements and insurance costs. Further information on certain risks to our Company is located in Item 1a of this Form 10-K.
 
Fiscal 2013 Financial Overview
 
Bank Default
 
On December 31, 2012, the Company announced it was in default of certain financial covenants set forth in the terms of its outstanding indebtedness with respect to its fiscal year ended September 30, 2012.   We continued to be in default throughout our fiscal year ended September 30, 2013 and through the date of this filing.  As a result, our lenders have the ability to require immediate payment of all indebtedness under our loan agreements.  While our lenders have not exercised this right, their ability to require immediate payment has caused all of our outstanding indebtedness to be accelerated to current classification in our consolidated financial statements.
 
 
21

 
The Company has accrued but not remitted monthly interest payments to its subordinated lender since February 2013 and does not expect to resume interest payments to its subordinated lender until it resolves its default with the senior lender.  The Company has made all principal and interest payments due to its senior lender through the date of this filing.  In addition to making the required principal payments of approximately $1.9 million during fiscal year 2013, the Company also repaid an additional $0.3 million of principal in connection with the contribution of its tissue sealant intellectual property to Xcede, a joint venture, formed on or about October 1, 2013.
 
Subsequent to yearend, in addition to our regular monthly interest and principal payments, we repaid an additional $1.25 million to Santander from cash received in connection with the sale of our lead paint analyzer business.  Management is continuing to pursue potential other sales transactions which, if consummated, would result in additional principal payments to the bank and also expects to continue discussions with its lenders to address the financial covenant situation.  Because of the continuing default of the financial covenants and the possibility of an acceleration of the indebtedness by the lenders, the Company has classified all its outstanding indebtedness as a current liability in the accompanying consolidated balance sheets.
 
Given the uncertainty created by the defaults under the Company’s outstanding indebtedness and sustained substantial losses from operations for the years ended September 30, 2013 and 2012, the Company's independent registered public accounting firm has included a “going concern” explanatory paragraph in its audit opinion for the year ended September 30, 2013.
 
In addition to the formation of the Xcede joint venture and the sale of the lead paint business, the Company has taken and will continue to take actions to improve its liquidity, including the implementation of a number of initiatives designed to conserve cash, improve profitability and right-size the cost structure of its various businesses.
 
2013 Overview of Results
 
In fiscal year 2013, we incurred a net loss of $8.7 million compared to a net loss of $4.3 million in 2012.  The net losses included goodwill and intangible asset impairment charges totaling $6.8 million and $2.3 million in 2013 and 2012, respectively. Our net losses, exclusive of the impairment loss amounts indicated above, decreased in 2013 to $1.9 million from $2.0 million in 2012.  Revenue declined 10.7% to $42.8 million in 2013 from $47.9 million in 2012.  Contract Research segment revenues declined $3.4 million primarily as a result of lower billable material and subcontractor costs partially offset by higher billable direct labor hours.  In addition, our Instruments segment revenues declined $1.3 million primarily as a result of the lack of availability of our updated lead paint analyzer which has not been approved for sale and our updated medical probe product which was not approved for sale until May 2013.  The disclosure above of our net loss exclusive of the impairment charges is a non-GAAP measure.  See page 33 for more information. 
 
As a result of the higher-than-expected costs related to the product upgrades and delays in product launches in our Instruments segment, the Company determined that there was a decline in the fair value of its Instruments segment, and we recorded a non-cash goodwill and intangibles impairment charge of $6.8 million for the year ended September 30, 2013.  Additionally, the Company incurred approximately $1.0 million in consulting and legal fees associated with evaluating strategic and restructuring alternatives, including the potential sale of product lines and/or a division.
 
As a result of the foregoing, our loss from operations for fiscal 2013 was $8.2 million, compared with a loss from operations of $3.7 million in fiscal 2012. The net loss for fiscal 2013 was $8.7 million, or $0.59 per share, compared with a loss of $4.3 million, or $0.29 per share, in 2012.
 
Recent Events
 
On or about October 1, 2013, Dynasil Biomedical formed Xcede, a joint venture with the Mayo Clinic, to spin out and separately fund the development of its tissue sealant technology. Xcede has initiated financing efforts and has received funding from internal sources and outside investors. To date, Xcede is 90% owned by Dynasil Biomedical and Dynasil Biomedical holds a majority of the seats on Xcede’s board of directors.  Although it is anticipated that the Company will continue for the foreseeable future to hold a significant equity interest in Xcede, the Company expects that its equity interest will decrease over time if and to the extent that Xcede is successful in raising equity financing from outside sources.
 
 
22

 
On November 7, 2013, the Company sold its Lead Paint detector business to Protec Instrument Corporation, a Delaware corporation (“Protec”), which is a wholly owned subsidiary of Laboratoires Protec S.A., a French corporation and former European distributor of the lead paint detector products.  The sales price totaled approximately $1.4 million, less certain adjustments and including the assumption of certain liabilities by Protec.  The transaction also resulted in payment of approximately $0.4 million in satisfaction of outstanding accounts receivable. Concurrently with the sale, the Company and Protec entered into a transition services agreement pursuant to which the Company will provide certain transitional services to Protec for up to five months after closing.  The Company used $1.25 million of the proceeds to repay amounts owed to Santander, as described above under “Bank Default”.
 
Results of Operations
 
Results of Operations for the Fiscal Year Ended September 30,
 
2013
 
 
 
Contract
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Research
 
 
Optics
 
 
Instruments
 
 
Biomedical
 
 
Total
 
Revenue
 
$
21,888,746
 
 
$
15,564,766
 
 
$
5,104,812
 
 
$
194,508
 
 
$
42,752,832
 
Gross Profit
 
 
9,821,711
 
 
 
5,647,680
 
 
 
2,421,846
 
 
 
194,508
 
 
 
18,085,745
 
SG&A
 
 
9,345,214
 
 
 
5,624,291
 
 
 
3,486,729
 
 
 
969,532
 
 
 
19,425,766
 
Impairment of goodwill & long-lived assets
 
 
-
 
 
 
-
 
 
 
6,829,072
 
 
 
-
 
 
 
6,829,072
 
Operating Income (Loss)
 
 
476,497
 
 
 
23,389
 
 
 
(7,893,955)
 
 
 
(775,024)
 
 
 
(8,169,093)
 
GM %
 
 
44.9
%
 
 
36.3
%
 
 
47.4
%
 
 
100.0
%
 
 
42.3
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Depreciation and Amortization
 
 
316,864
 
 
 
765,018
 
 
 
454,569
 
 
 
60,000
 
 
 
1,596,451
 
Capital expenditures
 
 
31,439
 
 
 
506,371
 
 
 
7,092
 
 
 
-
 
 
 
544,902
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Intangibles, Net
 
 
332,717
 
 
 
882,296
 
 
 
2,089,573
 
 
 
179,997
 
 
 
3,484,583
 
Goodwill
 
 
4,938,625
 
 
 
1,302,358
 
 
 
-
 
 
 
-
 
 
 
6,240,983
 
Total Assets
 
$
9,831,209
 
 
$
12,380,248
 
 
$
4,253,926
 
 
$
211,843
 
 
$
26,677,226
 
 
Results of Operations for the Fiscal Year Ended September 30,
 
2012
 
 
 
Contract
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Research
 
 
Optics
 
 
Instruments
 
 
Biomedical
 
 
Total
 
Revenue
 
$
25,273,308
 
 
$
16,055,952
 
 
$
6,452,603
 
 
$
105,287
 
 
$
47,887,150
 
Gross Profit
 
 
9,862,413
 
 
 
5,875,551
 
 
 
3,684,320
 
 
 
83,459
 
 
 
19,505,743
 
SG&A
 
 
9,523,642
 
 
 
5,398,350
 
 
 
5,065,794
 
 
 
939,149
 
 
 
20,926,935
 
Impairment of goodwill
 
 
-
 
 
 
-
 
 
 
2,284,499
 
 
 
-
 
 
 
2,284,499
 
Operating Income (Loss)
 
 
338,771
 
 
 
477,201
 
 
 
(3,665,973)
 
 
 
(855,690)
 
 
 
(3,705,691)
 
GM %
 
 
39.0
%
 
 
36.6
%
 
 
57.1
%
 
 
79.3
%
 
 
40.7
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Depreciation and Amortization
 
 
237,623
 
 
 
796,847
 
 
 
575,246
 
 
 
60,003
 
 
 
1,669,719
 
Capital expenditures
 
 
348,314
 
 
 
462,445
 
 
 
207,454
 
 
 
-
 
 
 
1,018,213
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Intangibles, Net
 
 
366,853
 
 
 
960,821
 
 
 
5,135,634
 
 
 
239,997
 
 
 
6,703,305
 
Goodwill
 
 
4,938,625
 
 
 
1,300,463
 
 
 
4,015,072
 
 
 
-
 
 
 
10,254,160
 
Total Assets
 
$
12,870,151
 
 
$
11,588,145
 
 
$
12,537,403
 
 
$
469,729
 
 
$
37,465,428
 
 
Revenue
 
Revenues for the fiscal year ended September 30, 2013 were $42.8 million. This represents a decrease of $5.1 million or 10.7% over revenues for the fiscal year ended September 30, 2012 of $47.9 million.  Contract Research revenues declined by $3.4 million or 13.4% as a result of downturns in research grants awarded by the Domestic Nuclear Detection Office (“DNDO”) of $2.0 million and the National Institutes of Health (“NIH”) of $1.2 million.  Governmental Agency contract awards are constrained by the Federal Budget and our contract revenues will reflect increases and decreases in contract awards that parallel Federal budgetary shifts.  More recently, DNDO awards have rebounded from FY 2013 levels, while NIH awards are continuing at 2013 levels, reflecting Government funding priorities.  The contract revenue backlog for contract research continues to be strong and is approximately $40 million, of which 48% is SBIR grants as of September 30, 2013.  The Company continues to seek to diversify its contracting sources and to limit its reliance on both the SBIR program and the limited number of government agencies that currently contract for research. This diversification also includes contract research for commercial businesses rather than governmental agencies. 
 
 
23

 
Revenues in the Optics segment decreased by $0.5 million or 3.1% to $15.6 million in fiscal 2013.  Substantially all the decline in revenues related to decreases in optical crystal sales which experienced slightly lower demand, primarily in Europe.
 
Revenues in the Instruments segment decreased $1.3 million or 20.9% to $5.1 million in fiscal year 2013. We believe the decrease was a result of customers delaying purchases of our existing products in anticipation of the availability of the newly refreshed products.  Our refreshed medical probe product began shipping in May 2013; however, we suspended work required to obtain HUD approval for our lead paint analyzer product in the second quarter of 2013.  Subsequent to our fiscal yearend, we completed the sale of the Lead Paint business in our Instrument segment as discussed in Note 18 in the Notes to the Consolidated Financial Statements.
 
The Biomedical segment revenues of $0.2 million were primarily associated with a technology development contract with the Mayo Clinic.
 
Gross Profit
 
Gross profit for fiscal year 2013 decreased $1.4 million or 7.3% to $18.1 million from the prior year amount of $19.5 million.  Gross profit as a percentage of revenue increased to 42.3% from 40.7% at September 30, 2012 primarily as a result of higher gross profit margins in the Contract Research segment partially offset by a decrease in the Instruments segment.
 
Gross profit remained essentially flat for the Contract Research segment despite the 13.4% decline in revenues.  Gross profit as a percentage of revenue increased to 44.9% from 39.0%, due to improvements in contract management in 2013 which reduced costs associated with losses incurred to complete contracts and costs incurred in excess of provisional contract rates.
 
The Optics segment’s gross profit decreased by $0.2 million or 3.9% while gross profit as a percentage of revenue remained essentially flat at 36.3% in 2013 compared to 36.6% in 2012. 
 
The Instrument segment’s gross profit decreased $1.3 million or 34.3% to $2.4 million in 2013 from $3.7 million in 2012.  Instrument segment’s gross profit as a percentage of revenue declined to 47.4% in 2013 from 57.1% in 2012 as a result of continuing fixed costs spread over a lower revenue volume; discounting of existing products during the periods when the refreshed product was not yet available; and lower revenue in 2013 of the RadCam product which has higher gross margins.
 
Selling, General & Administrative (“SG&A”) Expenses
 
SG&A expenses decreased $1.5 million to $19.4 million or 45.4% of revenue in fiscal year 2013, from $20.9 million or 43.7% of revenue for fiscal year 2012. SG&A expenses decreased primarily as a result of the substantial completion of the engineering costs associated with the product refreshes in our Instruments segment and the elimination in 2013 of approximately $0.5 million of expenses incurred in 2012 related to an internal review of billing and accounting practices and internal controls at the RMD division. This investigation has been satisfactorily completed and, as a result, the Company has adopted certain improved practices and internal controls.  No material additional expenses related to this matter were incurred in the fiscal year ended September 30, 2013.  These decreases were partially offset by increased sales and marketing expense in the Optics segment.
 
Contract Research SG&A decreased slightly to $9.3 million or 42.7% of revenue in fiscal 2013 from $9.5 million or 37.7% of revenue in the prior year. The increased percentage was primarily a result of SG&A costs being spread over lower revenues in 2013 as compared to 2012.
 
SG&A within the Optics segment increased $0.2 million to $5.6 million from $5.4 million in 2012.  The increase is related primarily to additional personnel added in sales and marketing and engineering.
 
 
24

 
The Instruments segment had the greatest decrease in SG&A costs, decreasing $1.6 million to $3.5 million or 68.3% of revenue in 2013 compared to $5.1 million or 78.5% of revenue in 2012.  This segment had two main product lines: a hand-held lead paint analyzer and a medical gamma probe used primarily in breast cancer treatment. The Company began a product refresh on both product lines in 2012 to enhance them with new features and functionality to maintain their market positions. The Company spent $1.3 million in fiscal year 2012 on research and development on the products and significant additional amounts on sales and marketing efforts in advance of the new product launches. In fiscal year 2013, these costs and other SG&A costs were substantially reduced while awaiting regulatory approval.  Regulatory approval for the medical gamma probe was received in May 2013 while efforts to obtain the approval of the lead paint analyzer were suspended in the second quarter of fiscal 2013 while the Company reviewed various strategic alternatives. 
 
As a result of the delays associated with both product lines and the review of strategic alternatives for the lead paint analyzer product, the Company performed an interim impairment test and recorded an impairment of goodwill and intangibles totaling $6.8 million in the quarter ending March 31, 2013.
 
Finally, SG&A costs in the Biomedical segment in fiscal year 2013 were approximately $1.0 million as compared to $0.9 million in fiscal year 2012.  These costs were incurred to advance the development of the three main technologies: hematology, hypothermic core cooling and tissue sealants. On or about October 1, 2013, Dynasil Biomedical formed Xcede, a joint venture with Mayo Clinic, to spin out and separately fund the development of the tissue sealant technology. While we believe these technologies are progressing favorably, they remain in the early stages of development and there can be no assurance that we will be able to successfully bring any of them to market.  We are continuing to explore the availability of outside financing, including through a sale, licensing or joint venture involving one or more of the remaining technologies, though we may not be able to secure any such financing arrangement on favorable terms or at all.
 
Net Interest Expense
 
Net interest expense increased to $0.9 million in fiscal 2013 from $0.6 million in fiscal 2012 primarily as a result of the $3.0 million borrowing from Massachusetts Capital Resources Company being outstanding for the full year in fiscal 2013 compared to 2 months in fiscal 2012.  The Company has been accruing interest on this debt at the default rate of 14% rather than the normal rate of 10% since it suspended interest payments in February 2013
 
Income Tax Credit
 
Total income tax expense (credit) increased from a tax credit of ($41,000) in fiscal 2012 to a tax credit of ($303,000) in fiscal 2013. The increase in the credit is due to lower state tax liability in 2013 compared to 2012 and higher foreign research credits claimed in 2013.
 
Net Loss
 
As a result, the Company had a net loss of $8.7 million for the year ended September 30, 2013 compared to a net loss of $4.3 million for the fiscal year ended September 30, 2012. Our net losses, exclusive of the impairment loss amounts indicated above, were $1.9 million in 2013 compared to $2.0 million in 2012.
 
Liquidity and Capital Resources
 
Liquidity Overview
 
On December 31, 2012, the Company announced it is in default of the financial covenants set forth in the terms of its outstanding indebtedness at September 30, 2012 and we remain in default as of September 30, 2013.  These covenants require the Company to maintain specified ratios of earnings before interest, taxes, depreciation and amortization (EBITDA) to fixed charges and to total/senior debt.  These financial covenant defaults give the lenders the right to accelerate the maturity of the indebtedness outstanding and foreclose on any security interest. Furthermore, the Company's lenders, may, at their option, impose default interest rates with respect to their indebtedness.  While we continue to be current with all principal and interest payments with Santander, we have not paid approximately $0.3 million in interest owed to MCRC.  As of the date hereof, neither of our lenders has accelerated our payment obligations. 
 
 
25

 
The causes for the covenant violations were lower revenue and higher than expected expenses  in the Company's Instruments and Contract Research segments during the fiscal quarter ended September 30, 2012 and continuing through fiscal 2013, combined with the continued investment in Dynasil Biomedical Corp. and the Company's Dual Mode nuclear detection initiative. In addition, in the fiscal quarter ended September 30, 2012, the Company incurred a significant, non-recurring charge of approximately $0.5 million to its selling, general and administrative expenses related to costs incurred as a result of a review of certain cash application processes and billing practices and internal controls of the RMD division.
 
As of September 30, 2013, the Company had total indebtedness outstanding of approximately $9.8 million, consisting of approximately $6.8 million of senior debt owed to Santander and approximately $3.0 million of subordinated debt owed to MCRC.
 
Subsequent to September 30, 2013, in addition to our regular monthly interest and principal payments, we repaid an additional $1.25 million to Santander from cash received in connection with the sale of our lead paint analyzer business.  We are continuing to evaluate potential alternatives that would resolve our current default status including additional sales transactions, negotiation of a forbearance agreement or a new borrowing arrangement with another lender.  However, we cannot provide any assurance that the alternatives will be successful or that our obligations under our debt agreements will not be accelerated in the future or that our lenders will not exercise other remedies for default.
 
Because of the uncertainty of any resolution of the covenant violations and the possibility of an acceleration of the indebtedness by the lenders, the Company has reclassified all of its outstanding indebtedness to current classification in the financial statements for the year ended September 30, 2013 and 2012 filed herewith. As a result of the above and the Company’s sustained substantial losses from operations for the years ended September 30, 2013 and 2012, the Company's independent registered public accounting firm, McGladrey LLP, has included a "going concern" explanatory paragraph in its audit opinion with respect to such financial statements.
 
Net cash as of September 30, 2013 was $2.4 million which was a decrease of $1.0 million as compared to $3.4 million at September 30, 2012.  The Company does not currently have cash available to satisfy its obligations under its indebtedness if it were to be accelerated or payment demanded.  If the Company is not able to resolve its current defaults under its outstanding indebtedness and improve its liquidity through the actions described above, it may not have sufficient liquidity to meet its anticipated cash needs for the next twelve months.
 
Net cash provided by operating activities
 
Net cash provided by operating activities was $1.7 million for fiscal year 2013 versus $0.7 million for fiscal year 2012. The fiscal year 2013 net loss was $8.7 million. There were non-cash expenses contained in the net loss including stock compensation expense of $0.4 million, depreciation and amortization expense of $1.6 million and the impairment of goodwill and long lived assets of $6.8 million. These major non-cash items totaled $8.8 million. The net change in assets and liabilities totaled $1.8 million. This included a $2.0 million decrease in billed and unbilled accounts receivable primarily as a result of improved billing and collection practices in the Contracts Research segment.  The decrease in assets was partially offset by an increase in liabilities of $0.5 million for accounts payable, accrued expenses and deferred revenue. 
 
Cash flows from investing activities
 
Cash flows used in investing activities were $0.5 million for fiscal 2013 compared with $1.0 million for fiscal 2012.  All expenditures in 2013 were made to purchase machinery and equipment.  There are currently plans for capital expenditures of $1.3 million during fiscal year 2014, depending on the availability of cash and/or financing.
 
Cash flows from financing activities
 
Cash flows from financing activities used $2.2 million of cash in fiscal 2013 and used $0.7 million of cash in fiscal 2012 primarily for regularly scheduled payments to Santander Bank under the five year term debt agreement.
 
 
26

 
Summary of Terms of Outstanding Indebtedness
 
Management expects to continue discussions with its lenders to address the financial covenant defaults as of September 30, 2013 as described above.  The following is summary of the terms of the existing loan agreement in place with the Company’s senior lender, Santander Bank, and the terms of subordinated debt owed to Massachusetts Capital Resources Company. 
 
Santander Bank Loan Agreement
 
On June 29, 2012, the Company entered into a letter agreement (the “Waiver Letter”) with Santander as well as Amendment No. 3 (the “Amendment”) to the Loan and Security Agreement, dated July 7, 2010, as amended on April 1, 2012 and April 12, 2012 (the “Original Loan Agreement”). Under the Waiver Letter, the Lender agreed to waive non-compliance by the Company with certain financial covenants under the Original Loan Agreement as of June 30, 2012, subject to the Company’s compliance with the terms of the Amendment, including the requirement that the Company would raise, on or before September 30, 2012, at least $2.0 million in gross proceeds from the sale of its capital stock and/or the incurrence of new indebtedness which is subordinated to the indebtedness in favor of the Lender, on terms and conditions acceptable to the Lender in its sole discretion (the “Required Capital Raise”) and applying the proceeds as described below, all of which the Company has successfully completed.
  
The Amendment also made certain other changes to the Original Loan Agreement, including certain financial covenants, limitations on capital expenditures and the termination of the Company’s acquisition line of credit, in each case as described in more detail below. The Amendment did not change the interest rates on outstanding indebtedness under the Original Loan Agreement.
 
The terms of the Amendment are described below:
 
 
·
The Required Capital Raise on or before September 30, 2012
 
Under the Amendment, the Company agreed with the Lender that the Company would raise, on or before September 30, 2012, at least $2.0 million in gross proceeds from the sale of its capital stock and/or the incurrence of new indebtedness which is subordinated to the indebtedness in favor of the Lender, on terms and conditions acceptable to the Lender in its sole discretion. As disclosed in the Company’s Form 8-K filed on June 8, 2012, the Company has incurred indebtedness in favor of certain entities affiliated with Dr. Gerald Entine (together, “Entine”) in the aggregate principal amount of $1,857,546 (the “Entine Indebtedness”). The Company incurred the Entine Indebtedness in satisfaction of its obligation to repurchase certain shares of Dynasil common stock from Entine pursuant to a put right exercised by Entine on February 12, 2012. The proceeds of the Required Capital Raise must first be used to repay all amounts outstanding under the Entine Indebtedness by September 30, 2012, and thereafter for general working capital needs. The Required Capital Raise has been completed as of July 31, 2012 pursuant to the Note Purchase Agreement (“the Agreement”) with Massachusetts Capital Resource Company described below. Pursuant to the terms of the Agreement, the Company issued and sold to MCRC a $3.0 million subordinated note (the “Subordinated Note”) for proceeds of $3.0 million.
 
 
·
Amendment to Leverage Ratio Covenants
 
For the Consolidated Maximum Leverage Ratio (Consolidated Total Funded Debt to Consolidated EBITDA, as defined in the Amendment), the Amendment (i) revised the required ratio for September 30, 2012 from 3.25x to 4.5x; (ii) revised the required ratio for December 31, 2012 from 3.0x to 4.5x; and (iii) revised the required ratio for March 31, 2013 and for each rolling four quarters thereafter from 3.0x to 4.0x.
 
The Amendment also included a new Consolidated Maximum Adjusted Leverage Ratio covenant, which is Consolidated Total Funded Debt (excluding subordinated debt) to Consolidated EBITDA, as defined in the Amendment. The Amendment requires the Company to maintain a Consolidated Maximum Adjusted Leverage Ratio equal to or less than (i) 3.25x to 1.00x for each of the rolling four quarter periods ending on September 30, 2012 and December 31, 2012, and (ii) 3.0x to 1.0x for each rolling four quarter period ending on or after March 31, 2013.
 
 
27

 
For the purposes of calculating both the Consolidated Maximum Leverage Ratio and the Consolidated Maximum Adjusted Leverage Ratio, Consolidated EBITDA (as defined in the Amendment) will be (i) at September 30, 2012, the actual Consolidated EBITDA for the 3 months then ended times 4; (ii) at December 31, 2012, the actual Consolidated EBITDA for the 6 months then ended times 2; and (iii) at March 31, 2013, the actual Consolidated EBITDA for the 9 months then ended times 4/3 (provided that the add-backs for costs are not annualized).
 
 
·
Amendment to Fixed Charge Coverage Ratio Covenants
 
For the Consolidated Fixed Charge Coverage Ratio, the Amendment (i) revised the required ratio for September 30, 2012 from 1.10x to 1.00x; (ii) revised the required ratio for December 31, 2012 from 1.20x to 1.00x; (iii) revised the required ratio for March 31, 2013 from 1.20x to 1.05x; (iv) revised the required ratio at June 30, 2013 from 1.20x to 1.10x; and (v) did not change the required ratio at September 30, 2013 (remained at 1.20x).
 
The Consolidated Fixed Charge Coverage Ratio is defined as Consolidated EBITDA (as defined in the Amendment) for the applicable period divided by the sum of (a) the Company’s consolidated interest expense for such period, plus (b) the aggregate principal amount of scheduled payments on the Company’s indebtedness made during such period (excluding any repayment of the Entine Indebtedness), plus (c) the sum of all cash dividends and other cash distributions to the Company’s shareholders during such period, plus (d) the sum of all taxes paid in cash by the Company during such period, less (e) up to $75,000 paid to the IRS, to the extent characterized as interest expense, in connection with certain historical tax filings (the “IRS Payments”).
 
For the purposes of calculating the Consolidated Fixed Charge Coverage Ratio, Consolidated EBITDA will be (i) at September 30, 2012, the actual Consolidated EBITDA for the 3 months then ended times 4; (ii) at December 31, 2012, the actual Consolidated EBITDA for the 6 months then ended times 2; and (iii) at March 31, 2013, the actual Consolidated EBITDA for the 9 months then ended times 4/3 (provided that the add-backs for Entine Indebtedness repayment and the IRS Payments are not annualized).
 
 
·
Restriction on Capital Expenditures 
 
For the fiscal year ending September 30, 2012, the Amendment reduced the limitation on the Company’s capital expenditures from $3.25 million to $2.25 million and for fiscal years ending September 30, 2013 and for each fiscal year thereafter, the Amendment raised the limitation on the Company’s capital expenditures from $2.00 million to $2.25 million.
 
 
·
Termination of Acquisition Line of Credit
 
The Amendment also accelerated the termination date of the Company’s $5 million acquisition line of credit to June 29, 2012, which prevented the Company from being able to draw on the approximately $1 million of previously available undrawn funds.
 
Note Purchase Agreement – Massachusetts Capital Resource Company
 
As described above, the Company is currently in financial default under its note purchase agreement with MCRC.
 
On July 31, 2012, the Company entered into the Agreement with MCRC. Pursuant to the terms of the Agreement, the Company issued and sold to MCRC the $3.0 million Subordinated Note for proceeds of $3.0 million. The Company has used a portion of the proceeds from the sale of the Subordinated Note to repay the Entine Indebtedness in the aggregate principal amount of $1.9 million and has agreed to use the balance of the proceeds for working capital purposes.
 
The Subordinated Note matures on July 31, 2017, unless accelerated pursuant to an event of default, as described below. The Subordinated Note bears interest at the rate of ten percent (10.0%) per annum, with interest to be payable monthly on the last day of each calendar month in each year, the first such payment to be due and payable on August 31, 2012. Under the terms of the Agreement, beginning on and with September 30, 2015, and on the last day of each calendar month thereafter through and including July 31, 2017, the Company will redeem, without premium, $130,434 in principal amount of the Subordinated Note together with all accrued and unpaid interest then due on the amount redeemed.
 
 
28

 
Under the terms of the Agreement and a Subordination Agreement dated July 31, 2012, among the Company, the Guarantor Subsidiaries, the Lender and MCRC, MCRC and any successor holder of the Subordinated Note have agreed that the payment of the principal of and interest on the Subordinated Note shall be subordinated in right of payment, to the prior payment in full of all indebtedness of the Company for money borrowed from banks or other institutional lenders at any time outstanding, including money borrowed from the Lender under the Original Loan Agreement.
 
The Agreement contains customary representations, warranties and covenants, including covenants by the Company limiting additional indebtedness, liens, guaranties, mergers and consolidations, substantial asset sales, investments and loans, sale and leasebacks, transactions with affiliates and fundamental changes. In addition, the Agreement contains financial covenants by the Company (as further defined in the Agreement) that (i) impose a Consolidated Maximum Leverage Ratio (consolidated total funded debt to consolidated EBITDA) equal to or less than (a) 5.0 to 1.0 for each of the rolling four quarter periods ending on September 30, 2012 and December 31, 2012, and (b) 4.5 to 1.0 for each rolling four quarter period ending on or after March 31, 2013, and (ii) require a Consolidated Fixed Charge Coverage Ratio (consolidated EBITDA to consolidated fixed charges) of not less than (a) .75 to 1.00 for each of the rolling four quarter periods ending on September 30, 2012 and December 31, 2012, (b) .8 to 1.0 for each of the rolling four quarter period ending on March 31, 2013 and June 30, 2013, and (c) .95 to 1.00 for each rolling four quarter period ending on or after September 30, 2013.
 
The Agreement also provides for events of default customary for agreements of this type, including, but not limited to, non-payment, breach of covenants, insolvency and defaults on other debt. Upon an event of default, MCRC may elect to declare all obligations (including principal, interest and all others amounts payable) immediately due and payable, which shall occur automatically if the Company becomes insolvent.
 
On September 26, 2013, Santander and MCRC agreed to certain amendments to the Loan and Security Agreement, dated July 7, 2010, as amended on April 1, 2012, April 12, 2012 and June 29, 2012 and the Note Purchase Agreement dated July 31, 2012, respectively, in order to permit the Company to form Xcede, a joint venture with the Mayo Clinic, to spin out and separately fund the development of the tissue sealant technology.
 
“Off Balance Sheet” Arrangements
 
The Company has no “Off Balance Sheet” arrangements.
 
NEW ACCOUNTING PRONOUNCEMENTS
 
See Note 2, "Summary of Significant Accounting Policies" in the Notes to Consolidated Financial Statements for a full description of recent accounting pronouncements, including the respective dates of adoption or expected adoption and effects on our consolidated financial position, results of operations and cash flows.
 
CRITICAL ACCOUNTING POLICIES
 
Our discussion and analysis of financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America and pursuant to the rules and regulations of the SEC.  The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  We have identified the following as the items that require the most significant judgment and often involve complex estimation: revenue recognition, valuation of long-lived assets, intangible assets and goodwill, estimating allowances for doubtful accounts receivable, stock-based compensation and accounting for income taxes.
 
Revenue Recognition
 
Revenue from sales of products is recognized at the time title and the risks and rewards of ownership pass.  Revenue is recognized when the products are shipped per customers’ instructions, the contract has been executed, the contract or sales price is fixed or determinable, delivery of services or products has occurred and the Company’s ability to collect the contract price is considered reasonably assured.
 
 
29

 
Revenue from research and development activities is derived generally from the following types of contracts:  reimbursement of costs plus fees, fixed price or time and material type contracts.  Government funded services revenues from cost plus contracts are recognized as costs are incurred on the basis of direct costs plus allowable indirect costs and an allocable portion of the contracts’ fixed fees.  Revenue from fixed-type contracts is recognized under the percentage of completion method with estimated costs and profits included in contract revenue as work is performed.  Revenues from time and materials contracts are recognized as costs are incurred at amounts generally commensurate with billing amounts.  Recognition of losses on projects is taken as soon as the loss is reasonably determinable. 
 
The majority of the Company’s contract research revenue is derived from the United States government and government related contracts.  Such contracts have certain risks which include dependence on future appropriations and administrative allotment of funds and changes in government policies.  Costs incurred under United States government contracts are subject to audit.  The Company believes that the results of such audits will not have a material adverse effect on its financial position or its results of operations.
 
Goodwill
 
Goodwill and intangible assets which have indefinite lives are subject to annual impairment tests.  Goodwill is tested by reviewing the carrying value compared to the fair value at the reporting unit level.  Fair value for the reporting unit is derived using the income approach.  Under the income approach, fair value is calculated based on the present value of estimated future cash flows.  Assumptions by management are necessary to evaluate the impact of operating and economic changes and to estimate future cash flows.  Management’s evaluation includes assumptions on future growth rates and cost of capital that are consistent with internal projections and operating plans.
 
The Company generally performs its annual impairment testing of goodwill during the fourth quarter of its fiscal year, or more frequently if events or changes in circumstances indicate that the assets might be impaired.  The Company tests impairment at the reporting unit level using the two-step process. The Company's primary reporting units tested for impairment are RMD, which comprises our Contract Research segment, Dynasil Products (also known as RMD Instruments), which comprises our Instruments segment, and Hilger Crystals, which is a component of the Optics segment.
 
Step one of the impairment testing compares the carrying value of a reporting unit to its fair value.  The carrying value represents the net book value of the net assets of the reporting unit or simply the equity of the reporting unit if the reporting unit is the entire entity.  If the fair value of the reporting unit is greater than its carrying value, no impairment has been incurred and no further testing or analysis is necessary.  The Company estimates fair value using a discounted cash flow methodology which calculates fair value based on the present value of estimated future cash flows.  Estimating future cash flows requires significant judgment and includes making assumptions about projected growth rates, industry-specific factors, working capital requirements, weighted average cost of capital, and current and anticipated operating conditions.  Assumptions by management are necessary to evaluate the impact of operating and economic changes.  The Company's evaluation includes assumptions on future growth rates and cost of capital that are consistent with internal projections and operating plans.  The use of different assumptions or estimates for future cash flows could produce different results.  The Company regularly assesses the estimates based on the actual performance of each reporting unit.
 
If the carrying value of a reporting unit is greater than its fair value, step two of the impairment testing process is performed to determine the amount of impairment to be recognized.  Step two requires the Company to estimate an implied fair value of the reporting unit's goodwill by allocating the fair value of the reporting unit to all of the assets and liabilities other than goodwill.  An impairment then exists if the carrying value of the goodwill is greater than the goodwill's implied fair value.  With respect to the Company's annual goodwill impairment testing performed during the fourth quarter of fiscal year 2013, step one of the testing determined the estimated fair value of RMD substantially exceeded its carrying value.  The estimated fair value of the Hilger Crystals reporting unit exceeded its carrying value by approximately 20%.  Accordingly, the Company concluded that no impairment had occurred and no further testing was necessary. 
 
 
30

 
During the second quarter of 2013, the Company performed an interim impairment test of long lived assets and goodwill associated with its Dynasil Products reporting unit and asset group.  Under step two of the impairment testing, the income method was used to allocate the fair values of all of the assets and liabilities of this reporting unit, with the remaining residual fair value allocated to goodwill.  The result of this impairment test was to write off Product’s goodwill totaling $4.0 million and approximately $2.8 million of its long lived assets other than goodwill for a total write-off of $6.8 million.
 
During the fourth quarter of 2012, the Company completed its annual goodwill impairment reviews and wrote off $2.3 million of impaired value of goodwill associated with the Products reporting unit.
 
Impairment of Long-Lived Assets
 
The Company's long-lived assets include property, plant and equipment and intangible assets subject to amortization.  The Company evaluates long-lived assets for recoverability whenever events or changes in circumstances indicate that an asset may have been impaired.  In evaluating an asset for recoverability, the Company estimates the future cash flow expected to result from the use of the asset and eventual disposition. If the expected future undiscounted cash flow is less than the carrying amount of the asset, an impairment loss, equal to the excess of the carrying amount over the fair value of the asset, is recognized.
 
During the second quarter of 2013, in connection with an interim impairment test of long lived assets and goodwill associated with its Dynasil Products reporting unit, the Company determined that the fair value of the long-lived assets (other than goodwill) of Products was less than the carrying amount of those assets and, as a result, recorded a pre-tax impairment charge of approximately $2.8 million plus a $4.0 million write-off of goodwill as discussed above.
 
There was no impairment charge during the year ended September 30, 2012.
 
Intangible Assets
 
The Company's intangible assets consist of an acquired customer base of Optometrics, LLC, acquired customer relationships and trade names of Hilger Crystals, customer relationships and trade names of Dynasil Products, acquired backlog and know-how of Radiation Monitoring Devices, Inc., and provisionally patented technologies within Dynasil Biomedical Corp. 
 
Dynasil estimates the fair value of indefinite-lived intangible assets using an income approach, and recognizes an impairment loss when the estimated fair value of the indefinite-lived intangible assets is less than the carrying value. During the fourth quarter of fiscal year 2013, the Company conducted its annual impairment review of indefinite-lived intangible assets with no impairments to the carrying values identified.
 
The Company reviews intangible assets with finite lives for impairment whenever events or changes in circumstances indicate the carrying value of an asset may not be recoverable. Recoverability of these intangible assets is assessed based on the undiscounted future cash flows expected to result from the use of the asset. If the undiscounted future cash flows are less than the carrying value, the intangible assets with finite lives are considered to be impaired. The amount of the impairment loss, if any, is measured as the difference between the carrying amount of these assets and the fair value based on a discounted cash flow approach or, when available and appropriate, to comparable market values.
The Company amortizes its intangible assets with definitive lives over their useful lives, which range from 4 to 15 years, based on the time period the Company expects to receive the economic benefit from these assets.
 
Allowance for Doubtful Accounts Receivable
 
We perform ongoing credit evaluations of our customers and adjust credit limits based upon payment history and the customer's current credit worthiness, as determined by our review of their current credit information. We continuously monitor collections and payments from our customers and maintain a provision for estimated credit losses based upon our historical experience and any specific customer collection issues that we have identified.  While such credit losses have historically been minimal, within our expectations and the provisions established, we cannot guarantee that we will continue to experience the same credit loss rates that we have in the past.  A significant change in the liquidity or financial position of any of our significant customers could have a material adverse effect on the collectability of our accounts receivable and our future operating results.
 
 
31

 
Stock-Based Compensation
 
We account for stock-based compensation using fair value.  Compensation costs are recognized for stock options granted to employees and directors.  Options and warrants granted to employees and non-employees are recorded as an expense over the requisite service period based on the grant date estimated fair value of the grant, determined using the Black-Scholes option pricing model.
 
Income Taxes
 
As part of the process of preparing our consolidated financial statements, we are required to estimate our income tax provision (benefit) in each of the jurisdictions in which we operate.  This process involves estimating our current income tax provision (benefit) together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes.  These differences result in deferred tax assets and liabilities, which are included within our consolidated balance sheets.  We regularly evaluate our ability to recover the reported amount of our deferred income taxes considering several factors, including our estimate of the likelihood of the Company generating sufficient taxable income in future years during the period over which temporary differences reverse.  The Company believes it is more likely than not that these carry-forwards will not be realized and, therefore, a valuation allowance has been applied.
 
Forward-Looking Statements
 
The statements contained in this Annual Report on Form 10-K which are not historical facts, are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.  These forward-looking statements regarding future events and our future results are based on current expectations, estimates, forecasts, and projections and the beliefs and assumptions of our management, including, without limitation, our expectations regarding results of operations, our default under the financial covenants under our loan agreement with Santander Bank and Massachusetts Capital Resource Company, Xcede obtaining financing from outside investors, the commercialization of our products including our dual mode detectors, our development of new technologies including at Dynasil Biomedical, the adequacy of our current financing sources to fund our current operations, our growth initiatives, our capital expenditures and the strength of our intellectual property portfolio.  These forward-looking statements may be identified by the use of words such as “plans”, “intends,” “may,” “could,” “expect,” “estimate,” “anticipate,” “continue” or similar terms, though not all forward-looking statements contain such words.  The actual results of the future events described in such forward-looking statements could differ materially from those stated in such forward-looking statements due to a number of important factors. These factors that could cause actual results to differ from those anticipated or predicted include, without limitation, our ability to resolve our current default under our outstanding indebtedness,  our ability to develop and commercialize our products, including obtaining regulatory approvals, the size and growth of the potential markets for our products and our ability to serve those markets, the rate and degree of market acceptance of any of our products, our ability to address our material weaknesses in our internal controls, general economic conditions, costs and availability of raw materials and management information systems, our ability to obtain and maintain intellectual property protection for our products, competition, the loss of key management and technical personnel, our ability to obtain timely payment of our invoices to governmental customers, litigation, the effect of governmental regulatory developments, the availability of financing sources, our ability to deleverage our balance sheet, our ability to identify and execute on acquisition opportunities and integrate such acquisitions into our business, and seasonality, as well as the uncertainties set forth in this Annual Report on Form 10-K, including the risk factors contained in Item 1a, and from time to time in the Company's other filings with the Securities and Exchange Commission. The Company disclaims any intention or obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise.
 
 
32

 
Use of Non-GAAP Financial Measures
 
In addition to financial measures prepared in accordance with generally accepted accounting principles (GAAP), this report also contains a measure of our net loss excluding goodwill and intangible asset impairment charges. The Company believes that the inclusion of this non-GAAP financial measure helps investors to gain a meaningful understanding of the Company’s core operating results and enhance comparing such performance with prior periods. Our management uses this non-GAAP measure, in addition to GAAP financial measures, as the basis for measuring our core operating performance and comparing such performance to that of prior periods. The non-GAAP financial measure included in this report is not meant to be considered superior to or a substitute for results of operations prepared in accordance with GAAP.
 
 
33

 
ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
 
Financial Statements
 
 
Page
Report of Independent Registered Public Accounting Firm
 
F-2
Consolidated Financial Statements:
 
 
Balance Sheets as of September 30, 2013 and 2012
 
F-3
Statements of Operations and Comprehensive Loss for the years ended September 30, 2013 and 2012
 
F-5
Statements of Stockholders’ Equity for the years ended September 30, 2013 and 2012
 
F-6
Statements of Cash Flows for the years ended September 30, 2013 and 2012
 
F-7
Notes to Consolidated Financial Statements
  
F-8
 
 
F-1

 
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
To the Board of Directors and Stockholders
Dynasil Corporation of America and Subsidiaries
Watertown, Massachusetts
 
We have audited the accompanying consolidated balance sheets of Dynasil Corporation of America and Subsidiaries (the Company) as of September 30, 2013 and 2012 and the related consolidated statements of operations and comprehensive loss, stockholders’ equity, and cash flows for the years then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
 
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Dynasil Corporation of America and Subsidiaries as of September 30, 2013 and 2012, and the results of their operations and their cash flows for the years then ended, in conformity with U.S. generally accepted accounting principles.

The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the consolidated financial statements, as of September 30, 2013, the Company is in default with the financial covenants set forth in the terms of its outstanding loan agreements (and may enter into a forbearance arrangement with its lenders) and has sustained substantial losses from operations for the years ended September 30, 2013 and 2012. These factors, among others, as discussed in Note 1 to the consolidated financial statements, raise substantial doubt about the Company’s ability to continue as a going concern. Management’s plan in regards to these matters is also described in Note 1. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
 
McGladrey LLP
 
Boston, Massachusetts
December 20, 2013
 
 
F-2

 
DYNASIL CORPORATION OF AMERICA AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, 2013 and 2012
 
 
 
September 30,
2013
 
September 30,
2012
 
ASSETS
 
Current Assets
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
2,436,828
 
$
3,414,880
 
Accounts receivable, net of allowances of $184,775 and $198,070
    at September 30, 2013 and September 30, 2012, respectively
 
 
3,657,320
 
 
5,475,142
 
Costs in excess of billings and unbilled receivables
 
 
1,537,318
 
 
1,735,798
 
Inventories, net of reserves
 
 
3,140,244
 
 
3,271,700
 
Prepaid expenses and other current assets
 
 
1,291,942
 
 
1,460,836
 
Total current assets
 
 
12,063,652
 
 
15,358,356
 
 
 
 
 
 
 
 
 
Property, Plant and Equipment, net
 
 
4,773,779
 
 
4,984,150
 
 
 
 
 
 
 
 
 
Other Assets
 
 
 
 
 
 
 
Intangibles, net
 
 
3,484,583
 
 
6,703,305
 
Goodwill
 
 
6,240,983
 
 
10,254,160
 
Deferred financing costs, net
 
 
114,229
 
 
165,457
 
Total other assets
 
 
9,839,795
 
 
17,122,922
 
 
 
 
 
 
 
 
 
Total Assets
 
$
26,677,226
 
$
37,465,428
 
 
 
 
 
 
 
 
 
LIABILITIES AND STOCKHOLDERS' EQUITY
 
Current Liabilities
 
 
 
 
 
 
 
Current portion of long-term debt
 
$
9,819,048
 
$
11,984,492
 
Capital lease obligations, current
 
 
124,383
 
 
-
 
Accounts payable
 
 
2,056,262
 
 
2,416,397
 
Deferred revenue
 
 
515,790
 
 
694,672
 
Accrued expenses and other liabilities
 
 
2,846,850
 
 
2,809,580
 
Total current liabilities
 
 
15,362,333
 
 
17,905,141
 
 
 
 
 
 
 
 
 
Long-term Liabilities
 
 
 
 
 
 
 
Capital lease obligations, net of current portion
 
 
232,173
 
 
-
 
Pension liability
 
 
249,966
 
 
345,443
 
Deferred tax liability
 
 
186,866
 
 
371,256
 
Total long-term liabilities
 
 
669,005
 
 
716,699
 
 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
F-3

 
DYNASIL CORPORATION OF AMERICA AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, 2013 and 2012 (Continued)
 
 
 
September 30,
2013
 
September 30,
2012
 
Stockholders' Equity
 
 
 
 
 
 
 
Common Stock, $0.0005 par value, 40,000,000 shares authorized,
    16,224,402 and 15,610,517 shares issued, 15,414,242 and and 14,800,357
    shares outstanding at September 30, 2013 and September 30, 2012, respectively.
 
 
8,112
 
 
7,805
 
Additional paid in capital
 
 
17,476,003
 
 
17,037,618
 
Accumulated other comprehensive income
 
 
152,685
 
 
61,906
 
Retained earnings (Accumulated deficit)
 
 
(6,004,570)
 
 
2,722,601
 
Less 810,160 shares of treasury stock - at cost
 
 
(986,342)
 
 
(986,342)
 
Total stockholders' equity
 
 
10,645,888
 
 
18,843,588
 
 
 
 
 
 
 
 
 
Total Liabilities and Stockholders' Equity
 
$
26,677,226
 
$
37,465,428
 
 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
F-4

 
DYNASIL CORPORATION OF AMERICA AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
FOR THE YEARS ENDED SEPTEMBER 30, 2013 and 2012
 
 
 
2013
 
2012
 
Net revenue
 
$
42,752,832
 
$
47,887,150
 
Cost of revenue
 
 
24,667,087
 
 
28,381,407
 
Gross profit
 
 
18,085,745
 
 
19,505,743
 
Operating expenses:
 
 
 
 
 
 
 
Sales and marketing expenses
 
 
1,746,865
 
 
1,729,703
 
Research and development expenses
 
 
2,307,407
 
 
2,810,778
 
General and administrative expenses
 
 
15,371,494
 
 
16,386,454
 
Impairment of goodwill and long-lived assets
 
 
6,829,072
 
 
2,284,499
 
Total operating expenses
 
 
26,254,838
 
 
23,211,434
 
Loss from operations
 
 
(8,169,093)
 
 
(3,705,691)
 
Interest expense, net
 
 
861,038
 
 
639,096
 
Loss before income taxes
 
 
(9,030,131)
 
 
(4,344,787)
 
Income tax credit
 
 
(302,960)
 
 
(41,021)
 
Net loss
 
$
(8,727,171)
 
$
(4,303,766)
 
 
 
 
 
 
 
 
 
Net loss
 
$
(8,727,171)
 
$
(4,303,766)
 
Other comprehensive loss:
 
 
 
 
 
 
 
(Increase) decrease in pension liability
 
$
92,513
 
$
(345,443)
 
Foreign currency translation
 
 
(1,734)
 
 
109,783
 
Total comprehensive loss
 
$
(8,636,392)
 
$
(4,539,426)
 
 
 
 
 
 
 
 
 
Basic net loss per common share
 
$
(0.59)
 
$
(0.29)
 
Diluted net loss per common share
 
$
(0.59)
 
$
(0.29)
 
 
 
 
 
 
 
 
 
Weighted average shares outstanding
 
 
 
 
 
 
 
Basic
 
 
14,812,858
 
 
14,811,294
 
Diluted
 
 
14,812,858
 
 
14,811,294
 
 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
F-5

 
DYNASIL CORPORATION OF AMERICA AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED SEPTEMBER 30, 2013 and 2012
 
 
 
 
 
 
 
 
Additional
 
Other
 
 
 
 
 
 
 
 
 
Total
 
 
 
Common
 
Common
 
Paid-in
 
Comprehensive
 
Retained Earnings
 
Treasury Stock
 
Stockholders'
 
 
 
Shares
 
Amount
 
Capital
 
Income (Loss)
 
(Accumulated Deficit)
 
Shares
 
Amount
 
Equity
 
Balance, September 30, 2011
 
15,393,053
 
$
7,696
 
$
15,896,755
 
$
297,566
 
$
7,026,367
 
810,160
 
$
(986,342)
 
$
22,242,042
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Issuance of shares of common stock
     under employee stock purchase plan
 
47,440
 
 
24
 
 
63,098
 
 
-
 
 
-
 
-
 
 
-
 
 
63,122
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Stock-based compensation costs
 
57,592
 
 
29
 
 
935,367
 
 
-
 
 
-
 
-
 
 
-
 
 
935,396
 
Exercise of options by director to
     purchase common stock
 
41,205
 
 
21
 
 
(21)
 
 
-
 
 
-
 
-
 
 
-
 
 
-
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Expiration of put shares
 
71,227
 
 
35
 
 
142,419
 
 
-
 
 
-
 
-
 
 
-
 
 
142,454
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Adjustment for increase in pension liability, net
     of tax
 
-
 
 
-
 
 
-
 
 
(345,443)
 
 
-
 
-
 
 
-
 
 
(345,443)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Foreign currency translation adjustment
 
-
 
 
-
 
 
-
 
 
109,783
 
 
-
 
-
 
 
-
 
 
109,783
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net loss
 
-
 
 
-
 
 
-
 
 
-
 
 
(4,303,766)
 
-
 
 
-
 
 
(4,303,766)
 
Balance, September 30, 2012
 
15,610,517
 
$
7,805
 
$
17,037,618
 
$
61,906
 
$
2,722,601
 
810,160
 
$
(986,342)
 
$
18,843,588
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Issuance of shares of common stock
     under employee stock purchase plan
 
28,622
 
 
14
 
 
20,995
 
 
-
 
 
-
 
-
 
 
-
 
 
21,009
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Stock-based compensation costs
 
585,263
 
 
293
 
 
417,390
 
 
-
 
 
-
 
-
 
 
-
 
 
417,683
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Adjustment for decrease in pension liability, net
     of tax
 
-
 
 
-
 
 
-
 
 
92,513
 
 
-
 
-
 
 
-
 
 
92,513
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Foreign currency translation adjustment
 
-
 
 
-
 
 
-
 
 
(1,734)
 
 
-
 
-
 
 
-
 
 
(1,734)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net loss
 
-
 
 
-
 
 
-
 
 
-
 
 
(8,727,171)
 
-
 
 
-
 
 
(8,727,171)
 
Balance, September 30, 2013
 
16,224,402
 
$
8,112
 
$
17,476,003
 
$
152,685
 
$
(6,004,570)
 
810,160
 
$
(986,342)
 
$
10,645,888
 
 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
F-6

 
DYNASIL CORPORATION OF AMERICA AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED SEPTEMBER 30, 2013 and 2012
 
 
 
2013
 
2012
 
Cash flows from operating activities:
 
 
 
 
 
 
 
Net loss
 
$
(8,727,171)
 
$
(4,303,766)
 
Adjustments to reconcile net loss to net cash:
 
 
 
 
 
 
 
Stock compensation expense
 
 
417,683
 
 
935,396
 
Foreign exchange loss
 
 
(4,867)
 
 
30,602
 
Contingent consideration adjustment
 
 
-
 
 
(17,376)
 
Gain on sale of property, plant and equipment
 
 
(87,803)
 
 
-
 
Depreciation and amortization
 
 
1,596,451
 
 
1,669,719
 
Noncash interest expense
 
 
51,228
 
 
41,799
 
Change in reserves
 
 
6,831
 
 
76,981
 
Deferred income taxes
 
 
(120,634)
 
 
166,920
 
Impairment of goodwill and long-lived assets
 
 
6,829,072
 
 
2,284,499
 
Other changes in assets and libilities:
 
 
 
 
 
 
 
Accounts receivable, net
 
 
1,822,982
 
 
(2,107,477)
 
Inventories
 
 
132,185
 
 
(134,449)
 
Costs in excess of billings / unbilled receivables
 
 
198,480
 
 
1,121,344
 
Prepaid expenses and other assets
 
 
100,900
 
 
(574,652)
 
Accounts payable
 
 
(364,330)
 
 
338,205
 
Accrued expenses and other liabilities
 
 
29,061
 
 
470,637
 
Deferred revenue
 
 
(178,882)
 
 
694,672
 
Net cash provided by operating activities
 
 
1,701,186
 
 
693,054
 
 
 
 
 
 
 
 
 
Cash flows from investing activities:
 
 
 
 
 
 
 
Proceeds from sale of property, plant, and equipment
 
 
80,252
 
 
-
 
Purchases of property, plant and equipment
 
 
(544,902)
 
 
(1,018,213)
 
Net cash from investing activities
 
 
(464,650)
 
 
(1,018,213)
 
 
 
 
 
 
 
 
 
Cash flows from financing activities:
 
 
 
 
 
 
 
Proceeds from issuance of common stock
 
 
21,009
 
 
63,122
 
Payment of debt issuance costs
 
 
-
 
 
(56,600)
 
Principal payments on capital leases
 
 
(76,397)
 
 
-
 
Buy back of common stock
 
 
-
 
 
(1,857,546)
 
Proceeds from long term debt
 
 
-
 
 
3,000,000
 
Payments on long-term debt
 
 
(2,165,444)
 
 
(1,860,678)
 
Net cash from financing activities
 
 
(2,220,832)
 
 
(711,702)
 
 
 
 
 
 
 
 
 
Effect of exchange rates on cash and cash equivalents
 
 
6,244
 
 
(28,099)
 
 
 
 
 
 
 
 
 
Net decrease in cash and cash equivalents
 
 
(978,052)
 
 
(1,064,960)
 
 
 
 
 
 
 
 
 
Cash and cash equivalents, beginning
 
 
3,414,880
 
 
4,479,840
 
Cash and cash equivalents, ending
 
$
2,436,828
 
$
3,414,880
 
 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
F-7

 
DYNASIL CORPORATION OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2013 and 2012
 
Note 1 – Nature of Operations and Ability to Continue as a Going Concern
 
Nature of Operations
 
The Company is primarily engaged in the development, marketing and manufacturing of detection, sensing and analysis technology, precision instruments and optical components as well as contract research. The Company’s products and services are used in a broad range of application markets including the homeland security, industrial and medical markets sectors. The products and services are sold throughout the United States and internationally.
 
Liquidity
 
The accompanying consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America, which contemplates continuation of the Company as a going concern. However, the Company has failed to comply with the financial covenants set forth in the terms of its outstanding agreements and sustained a substantial loss from operations. These factors raise substantial doubt over the Company’s ability to continue as a going concern.
 
The Company is currently in default of the financial covenants set forth in the terms of its outstanding indebtedness for its fiscal fourth quarter ended September 30, 2012 and has been in continuing default for each of its quarters in the year ended September 30, 2013. These covenants require the Company to maintain specified ratios of earnings before interest, taxes, depreciation and amortization (EBITDA) to fixed charges and to total/senior debt. A default gives the lenders the right to accelerate the maturity of the indebtedness outstanding. Furthermore, the Company’s lenders, may, at their option, impose default interest rates with respect to their debt outstanding. To date, the lenders have not taken any such actions. However, the Company cannot predict when or whether a resolution of this situation will be achieved.
 
While the Company has continued to be current with all principal and interest payments with Santander, we have not paid approximately $300,000 in interest owed to Massachusetts Capital Resources Company (“MCRC”), its subordinated lender.
 
Because of the uncertainty of any resolution of the covenant violations and possibility of an acceleration of the indebtedness by the lenders, the Company has reclassified all of its outstanding indebtedness as a current liability for the fiscal years ended September 30, 2013 and 2012. The Company’s ability to continue as a going concern is dependent upon its ability to generate future profitable operations and positive cash flows and/or to obtain the necessary financing from shareholders or other sources to meet its obligations and repay its liabilities arising from normal business operations when they become due.
 
In view of the matters described in the preceding paragraphs, recoverability of a major portion of the recorded asset amounts shown in the accompanying consolidated balance sheet is dependent upon the continued operations of the Company. The consolidated financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or amounts and classification of liabilities that might be necessary should the Company be unable to continue in existence.
 
The Company has taken and will continue to take actions to improve its liquidity including the sale of certain businesses and other initiatives designed to conserve cash and right-size the cost structure of its various business units. While the Company is actively pursuing sales transactions, there can be no assurance that any such transactions will occur. The Company does not currently have cash available to satisfy its obligations under its indebtedness if it were to be accelerated or payment demanded. If the Company is not able to resolve its current defaults under its outstanding indebtedness and improve its liquidity through the actions described above, it may not have sufficient liquidity to meet its anticipated cash needs for the next twelve months.
 
 
F-8

 
DYNASIL CORPORATION OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2013 and 2012
 
Note 2 – Summary of Significant Accounting Policies
 
Use of Estimates
 
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts of assets and liabilities and the disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  Actual results could differ from those estimates.
 
Principles of Consolidation
 
The accompanying consolidated financial statements include the accounts of Dynasil Corporation of America (“Dynasil” or the “Company”) and its wholly-owned subsidiaries: Optometrics Corporation (“Optometrics”), Evaporated Metal Films Corp (“EMF”), Dynasil Products, formerly known as RMD Instruments Corp. (“Dynasil Products”), Radiation Monitoring Devices, Inc. (“RMD”), Hilger Crystals, Ltd (“Hilger”) and Dynasil Biomedical Corp (“Dynasil Biomedical”).  All significant intercompany transactions and balances have been eliminated.
 
Revenue Recognition
 
Revenue from sales of products is recognized at the time title and the risks and rewards of ownership pass.  Revenue is recognized when the products are shipped per customers’ instructions, the contract has been executed, the contract or sales price is fixed or determinable, delivery of services or products has occurred and the Company’s ability to collect the contract price is considered reasonably assured.
 
Revenue from research and development activities is derived generally from the following types of contracts:  reimbursement of costs plus fees, fixed price or time and material type contracts.  Government funded services revenues from cost plus contracts are recognized as costs are incurred on the basis of direct costs plus allowable indirect costs and an allocable portion of the contracts’ fixed fees.  Revenue from fixed-type contracts is recognized under the percentage of completion method with estimated costs and profits included in contract revenue as work is performed.  Revenues from time and materials contracts are recognized as costs are incurred at amounts represented by agreed billing amounts.  Recognition of losses on projects is taken as soon as the loss is reasonably determinable.  The Company has an accrual for contract losses in the amount of $109,000 and $90,162 as of September 30, 2013 and 2012, respectively.
 
The majority of the Company’s contract research revenue is derived from the United States government and government related contracts.  Such contracts have certain risks which include dependence on future appropriations and administrative allotment of funds and changes in government policies.  Costs incurred under United States government contracts are subject to audit.  The Company believes that the results of such audits will not have a material adverse effect on its financial position or its results of operations.
 
Allowance for Doubtful Accounts Receivable
 
The Company performs ongoing credit evaluations of its customers and adjusts credit limits based upon payment history and the customer's current credit worthiness, as determined by a review of their current credit information.  The Company continuously monitors collections and payments from our customers and maintains a provision for estimated credit losses based upon historical experience and any specific customer collection issues that have been identified.  While such credit losses have historically been minimal, within expectations and the provisions established, the Company cannot guarantee that it will continue to experience the same credit loss rates as in the past.  A significant change in the liquidity or financial position of any significant customers could have a material adverse effect on the collectability of accounts receivable and future operating results.  When all collection efforts have failed and it is deemed probable that a customer account is uncollectible, that balance is written off against the existing allowance.
 
 
F-9

 
DYNASIL CORPORATION OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2013 and 2012
 
Note 2 – Summary of Significant Accounting Policies (continued)
 
Shipping and Handling Costs
 
The amounts billed for shipping and included in net revenue were approximately $100,000 and $118,800 for 2013 and 2012, respectively.
 
Research and Development
 
The Company expenses research and development costs as incurred.  Research and development costs include salaries, employee benefit costs, direct project costs, supplies and other related costs. Substantially all the Contract Research segment’s cost of revenue relates to research contracts performed by RMD which are in turn billed to the contracting party. Amounts of research and development included within cost of revenue for the years ended September 30, 2013 and 2012 were $12,172,000 and $15,411,000, respectively. Remaining amounts are recorded within selling, general and administrative expenses on the consolidated statements of operations.
 
Costs in Excess of Billings and Unbilled Receivables
 
Costs in excess of billings and unbilled receivables relate to research and development contracts and consists of actual costs incurred plus fees in excess of billings at provisional contract rates.
 
Patent Costs
 
Costs incurred in filing, prosecuting and maintaining patents (principally legal fees) are expensed as incurred and recorded within selling, general and administrative expenses on the consolidated statements of operations. Such costs aggregated approximately $422,000 and $393,000 for the years ended September 30, 2013 and 2012, respectively. 
 
Inventories
 
Inventories are stated at the lower of average cost or market.  Cost is determined using the first-in, first-out (FIFO) method and includes material, labor and overhead.  Inventories consist primarily of raw materials, work-in-process and finished goods.
 
A significant decrease in demand for the Company's products could result in a short-term increase in the cost of inventory purchases and an increase of excess inventory quantities on hand. In addition, as technologies change or new products are developed, product obsolescence could result in an increase in the amount of obsolete inventory quantities on hand. Therefore, although the Company makes every effort to ensure the accuracy of its forecasts of future product demand, any significant unanticipated changes in demand or technological developments could have a significant impact on the value of the inventory and reported operating results. The Company records, as a charge to cost of revenues, any amounts required to reduce the carrying value to net realizable value.
 
Property, Plant and Equipment
 
Property, plant and equipment are recorded at cost or at fair market value for acquired assets.  Depreciation is provided using the straight-line method over the estimated useful lives of the respective assets.
 
The estimated useful lives of assets for financial reporting purposes are as follows:  building and improvements, 8 to 25 years; machinery and equipment, 5 to 10 years; office furniture and fixtures, 5 to 10 years; transportation equipment, 5 years. Maintenance and repairs are charged to expense as incurred; major renewals and betterments are capitalized.  When items of property, plant and equipment are sold or retired, the related costs and accumulated depreciation are removed from the accounts and any gain or loss is included in income.
 
 
F-10

 
DYNASIL CORPORATION OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2013 and 2012
 
Note 2 – Summary of Significant Accounting Policies (continued)
 
Goodwill
 
The Company annually assesses goodwill impairment at the end of the fourth quarter of the fiscal year by applying a fair value test. In the first step of testing for goodwill impairment, the Company estimates the fair value of each reporting unit.  The reporting units have been determined as RMD which is the Contract Research reportable segment, Dynasil Products which is the Instruments reportable segment and Hilger Crystals, which is a component of the Optics reportable segment. The Company compares the fair value with the carrying value of the net assets assigned to each reporting unit. If the fair value is less than its carrying value, then the Company performs a second step and determines the fair value of the goodwill. In this second step, the fair value of goodwill is determined by deducting the fair value of a reporting unit’s identifiable assets and liabilities from the fair value of the reporting unit as a whole, as if that reporting unit had just been acquired and the purchase price were being initially allocated. If the fair value of the goodwill is less than its carrying value for a reporting unit, an impairment charge is recorded to earnings.
 
To determine the fair value of each of the reporting units as a whole, the Company uses a discounted cash flow analysis, which requires significant assumptions and estimates about the future operations of each reporting unit. Significant judgments inherent in this analysis include the determination of appropriate discount rates, the amount and timing of expected future cash flows and growth rates. The cash flows employed in the discounted cash flow analyses are based on financial forecasts developed internally by management. The discount rate assumptions are based on an assessment of the Company’s risk adjusted discount rate, applicable for each reporting unit. In assessing the reasonableness of the determined fair values of the reporting units, the Company evaluates its results against its current market capitalization.
 
In addition, the Company evaluates a reporting unit for impairment if events or circumstances change between annual tests indicating a possible impairment. Examples of such events or circumstances include the following:
 
 
a significant adverse change in legal status or in the business climate,
 
 
 
 
an adverse action or assessment by a regulator, 
 
 
 
 
a more likely than not expectation that a segment or a significant portion thereof will be sold, or
 
 
 
 
the testing for recoverability of a significant asset group within the segment.
 
Intangible Assets
 
The Company's intangible assets consist of acquired customer relationships, trade names, acquired backlog, know-how and provisionally patented technologies. The Company amortizes its intangible assets with definitive lives over their useful lives, which range from 4 to 15 years, based on the time period the Company expects to receive the economic benefit from these assets. 
The Company has a trade name related to its UK subsidiary that has been determined to have an indefinite life and is therefore not subject to amortization and is reviewed at least annually for potential impairment. The fair value of the Company’s trade name is estimated and compared to its carrying value to determine if impairment exists. The Company estimates the fair value of this intangible asset based on an income approach using the relief-from-royalty method. This methodology assumes that, in lieu of ownership, a third party would be willing to pay a royalty in order to exploit the related benefits of this asset.  This approach is dependent on a number of factors, including estimates of future sales, royalty rates in the category of intellectual property, discount rates and other variables.  Significant differences between these estimates and actual results could materially affect the Company’s future financial results.
 
 
F-11

 
DYNASIL CORPORATION OF AMERICA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2013 and 2012
 
Note 2 – Summary of Significant Accounting Policies (continued)
 
Recovery of Long-Lived Assets
 
The Company continually assesses whether events or changes in circumstances have occurred that may warrant revision of the estimated useful lives of its long-lived assets (other than goodwill and any indefinite lived assets) or whether the remaining balances of those assets should be evaluated for possible impairment. Long-lived assets include, for example, customer relationships, trade names, backlog, know-how and provisionally patented technologies. Events or changes in circumstances that may indicate that an asset may be impaired include the following:
 
 
a significant decrease in the market price of an asset or asset group,
 
 
 
 
a significant adverse change in the extent or manner in which an asset or asset group is being used or in its physical condition,